It has been
said, and if not, let it be said here today that the sound money
principle as defined by Mises
is a sovereign protector of the system of private property - itself
charged with the protection of civil liberties essential to the
individual's freedom, as well as of market processes responsible
to his prosperity. And to the extent that a society with its liberties
intact is a just society and a just society a moral one, liberty
is sovereign to a strong moral code.
Isn't that our connection
between money and morality? Doesn't sound money help us to achieve
liberty, and liberty in turn help us become a just and moral society?
If so, to the extent that
the fiat monetary regime undermines the capability of free market
mechanisms and overrides their role in the allocation of scarce
resources, the system of private property is clearly compromised,
since it is based on the idea that market prices determine what
should be produced for the economy. To the extent that it is not
a market economy, meaning an economy governed by (an efficient)
price mechanism, it is a planned economic system.
Accordingly the usual mismanagement
of a planned economic system, dubbed moral hazard, will result
in massive unemployment once the ephemeral impetus to its goal
toward full employment ceases to provide effective stimulus. Then
the true costs of such a system will either reveal themselves
or be deferred by the administrators of the system, who will mastermind
a new set of variables that will respond to their stimulus, and
which will fully employ the nation's economic resources.
Sooner or later, such an
economic system breaks down. Not because the guys at the Treasury
or Fed run out of ideas, but because their ideas no longer work.
Why, how could they keep working? If they could then the system
of private property is indeed obsolete. For it is the market mechanism
that has until today been thought to best decide how to allocate
the nation's scarce resources. Today, it isn't the market that
provides us with cheap energy, cheap credit, and cheap foreign
goods. It is economic "policy" that does, which is a direct rejection
of the sound money principle, the consequences of which history
has decided the same way it is deciding today.
- Ed Bugos
- The Money is No Good
A rejoinder to The
Deflation Monster, by Jude Wanniski (October 6,
2001), and all deflationists, as well as an update on the inflation
vs. deflation debate.
|CRB Index 1995-2001
||Gold prices 1995-2001
In describing the sound money principle
Ludwig von Mises says that there is just one basic condition that
needs to be met, and to make it easy for critics of the principle
to grasp he quoted it in both the affirmative and negative:
"Thus the sound money principle
has two aspects. It is affirmative in approving the market's choice
of a commonly used medium of exchange. It is negative in obscuring
the government's propensity to meddle with the currency system."
- Mises, on the principle of sound money, pp454, the Theory
of Money and Credit
In modern society you cannot have
the first without ensuring the second. It sure would be nice to
define everything in positive terms, but we can't do that with rules.
I wonder if the sign: "Please walk on cement" would be as effective
as the sign on someone's lawn that says, "Please keep off," especially
if you're dealing with insects with an appetite for grass.
At any rate, Professor Jude Wanniski
without question violates the tenet of the sound money principle
by denying the market its choice for a commonly used medium of exchange
(which is the case when you fix exchange rates), and also by sponsoring
the government's propensity to meddle with the currency system.
So today we are going to show you
why we believe that a true deflation outcome is not possible unless
either Professor Jude Wanniski realizes his and Robert Mundell's
dream, or until "after" the inflationist agenda our economic system
operates on has broken down. Yes we have had inflation, but it has
not yet manifested in our money because it (the inflation) hasn't
yet broken down.
By the time you're finished this
article, I'm certain you'll understand what we mean by that statement.
Undoubtedly many symptoms of deflation are with us today. Symptoms
are how the neighborhood Doctor guesses at what his patients have
come down with. Doctors, as well as mechanics or your technical
support staff, and would you believe even economists unfortunately
do not have a convenient gadget that reliably reveals what the problem
is. It usually comes down to a process of elimination. That
is brutally primitive indeed, but true.
What's more, there is no other way
until we have developed very advanced artificial intelligence, which
mere existence would scare the pants off most people, yet which
would probably work the same way, just faster.
But what if a particular symptom
is shared by more than one kind of illness? Or, in this case, what
if some of today's deflationary symptoms are shared by causes other
than deflation? How does the analyst (or Doctor) make his diagnosis
then? Well, for starters, once facts have been collected, he or
she could try to explain away some of the less likely sources or
causes. This isn't easy to do because it means the analyst must
What other explanation, for instance,
could there be for a decline in the dollar price of certain goods,
"besides" deflation? Could there be more than one?
Sure there could. If something other
than deflation came along and swept the value of the dollar up against
every other currency in the world, what might happen to the price
of commodities denominated in dollars? Couldn't the foreign exchange
value of a currency import deflationary pressures, as easily as
it could inflationary ones? The short, short answer is yes. Thus,
the analyst is faced with trying to determine today whether deflation
is the cause of the dollar's ascent, or whether other forces better
explain the dollar's ascent, which in turn imports deflationary
like forces. This is so important because one is natural,
for lack of a smarter term, and the other must be, well, reversible.
Nevertheless, the steadfast deflationist
(already failing in objectivity owing to title) would say that the
dollar is up against other fiat currencies as well as against commodity
prices due to deflation. To which we might reply that the level
of trickery alone (symptoms of a managed dollar), explicit by dollar
policy today, indicate that a managed dollar is behind the ascent
in the subjective, and perhaps objective
, exchange value of the dollar. But then, we would be dubbed conspiracy
Certainly, deflation is a force that
tends to manifest in a rising objective exchange value of money
(declining prices for commodities exchanged for it) just like inflation
is a source of an ultimate decline in the objective exchange value
of money. Further, both inflation and deflation are likely to manifest
in foreign exchange contracts, but on a relative basis. Thus, it
is tempting to conclude that if these symptoms of deflation show
up in both the objective and subjective exchange value of money
that deflation must be the cause.
In October, Jude Wanniski
took it upon himself to claim victory in an at least a decade long
struggle to prove once and for all that deflation was among us,
has been ever since he warned us so in 1995, and in fact has been
the force that the Fed has been fighting all along. Thus, we consider
Mr. Wanniski to be a good representation of the deflation argument.
He argues that this deflation has
been spreading through Asia, Russia, Brazil, the US, and now Argentina
and Zimbabwe. He claims that Japan is on its 12th year of deflation,
referencing the doubling of the yen against the dollar since then.
And his most valuable indicator is the relentless bear market that
gold prices have been in since.
He is saying that the declining dollar
price of gold indicates that what is behind these economic collapses
is deflation. Pretty convincing but I like our argument better.
Currencies Collapse From Inflation
Currencies from Russia to Asia to South America are not collapsing
due to deflation, but rather to the weight of their own relentless
inflation policies, which examples they have imported from the Federal
Reserve. If this were true then those particular currencies would
decline against both gold and the dollar, which they did. But why
was it the dollar that was preferred to gold over this period? Before
we try to answer that, note that in some cases such as Argentina
and certain Asian countries that are indeed dollarized and indebted
in terms of the dollar this does not apply.
The consequence of poorer monetary
policy abroad has been a boon for the value of the dollar this past
decade, and boy did Wall Street learn how to recycle all of that
fresh dollar demand. The more dollars that were demanded, the more
were created, as deposits held inside of the United States were
pyramided into the largest credit bubble ever seen. Here is a visual:
All of these dollars are backed by
the credit in the chart on the right. They are in demand because
they offer an investment premium during the typical cyclical upturn
in the US credit cycle, not for the value of their convertibility.
It is the kind of demand that spurs inflation not deflation, and
it is the kind of demand that drove this credit bubble. Let's expand
on the topic.
Unbeknownst to Jude Wanniski's Wall
Street clients then, are that there are other reasons, which perhaps
better explain the dollar's strength than deflation.
The Inflated Investment Premium
Recall in last week's GIC how we showed that the dollar is in a
primary down trend against the yen, and has been topping against
the euro since September 2000. The dollar's strength has predominantly
been against the secondary currencies, over the last few legs of
the recent bullish sequence in the dollar index, where inflation
rates are generally higher.
That said recent rate cuts from the
ECB portend rising rates of inflation in Europe, and perhaps a renewed
bull leg for the dollar over the euro. That situation needs to be
monitored closely. By the way, has credit money ever been legal
tender before? I would love anyone's views on that (mailto:firstname.lastname@example.org).
Moreover, we showed that in the long
run there is an inverse relationship between the relative growth
rate of an economy's money supply and the Forex value of its currency,
meaning that the higher one is, the lower the other one should be.
Thus the country with the lower relative inflation (in money supply)
over an extended period of time should be the one with a stronger
currency, which should transmit net deflationary pressures, or deflation
like symptoms, all else being equal.
the tendence for US Money Supply to grow faster over the long term;
Compare that trend to the FX value of the Yen over the long term
We also showed last week how exchange
rates are determined in the medium term by capital flowing across
the border seeking an optimum ROI (return on investment). This is
the cyclical component to currency movements we discussed in relation
to an investment premium.
And in the short run, we should all
know that between dollar policy and US economic policy, not only
certain FX behaviors are managed, but also that certain commodity
prices are managed. We know that the Department of Energy sells
oil when prices are high and buys it when prices are low, for instance,
but some of us suspect too that they attempt to influence these
prices to achieve broader aims.
The point is that the dollar
did not begin its cyclical rise in 1995 as the consequence of
any deflation, but because foreign exchange participants attached
an increasing investment premium to the dollar.
I bet that's "a new one on JW" as
well (private joke).
For instance, I believe it was George
Soros that observed that one little thing, which may have started
the whole ride, and which he does so well. In 1994, the "volatility"
(collapse) in the long bond was perceived to be the result of an
SEC regulation requiring U.S. banks to mark-to-market their bond
portfolio each quarter. So they rigged it so that their income statements
would no longer show losses when bond prices declined, unless the
bank sold its bonds. This way, bank stocks quickly became a hot
item in foreign accounts. Consider this to be another policy trick.
Ad-hoc policy maneuvering like this
of course explains why the enormous inflation of the period was
drawn to financial assets, or perhaps why the financial markets
prompted so much inflation, rather than the commodities. Fed policy
adapted to the new game quickly, and it learned how to create demand
for dollars. Alan Greenspan became a market mover.
On the other hand, it is also entirely
possible that chance alone "could" have brought about the unique
confluence of events that sent the dollar and financial markets
into a feedback loop where a rising expected return on investment
in US assets both inflated, and was inflated by, the growth in money
supply, while gold prices just sunk and stunk.
I guess we can argue this point until
we are red in the face that the dollar benefited from a rising investment
premium during that time, and I presume that few would disagree.
Yet, despite the four consecutive back-to-back double-digit gains
in the S&P 500 index during this period the Jude Wanniski's of the
world say deflation is indeed what has forced certain foreign currencies
down against the dollar, that there must be no other significant
explanation for the fact. Poppycock.
What is Inflation & Deflation?
So the specter of deflation is inexorable, and ever present in the
prognosis of current economic developments here and abroad. It follows,
however, that if most people do not understand inflation despite
its undeniable permeation in nearly all aspects of our lives, then
the rare deflationary episodes in our plight this century cannot
help us to understand the mysterious deflation monster any better.
The casual observer of economics
understands inflation to be a rise in the consumer price index,
and deflation to be its anti-thesis. In fact, the whole topic of
deflation is seen to be the anti-thesis of inflation, as though
deflation naturally follows inflation.
It can if the quality of the monetary
unit isn't sacrificed.
As long as economic growth
is stimulated through the equivalent of monetary debasement, it
is not likely that the economy will ever have real deflation UNLESS
either a new monetary choice is preferred, or something else comes
along to change the nature of that money, including either devaluation
if it is legal, or international agreement.
While accusing the Fed and US Treasury
of pursuing the policies of deflation, Jude Wanniski claims that
both inflation and deflation represent a decline in the monetary
standard. At first, his definition of deflation was fairly correct.
He said that deflation was a significant undersupply of money relative
to demand (for money). But then he started to mix up deflation with
its symptoms, and seemed to conclude that deflation represents a
decline in the monetary standard. This is at best a variation of
To be sure it wasn't clear from his
writing if this is what he meant but quoting Robert Mundell who
says that "Inflation is a decline in the monetary standard,"
he alleges that deflation is also a decline in the monetary standard,
due to the influence it has on defaults and bankruptcies in the
US and anywhere else. Thus, he argues, we ought to rid ourselves
of the evils of both inflation and deflation, through policy, which
will presumably work once we understand them in this way.
Despite the fact that he endorses
our argument about the quality of money, he does not seem to be
able to grasp the proper reason for its deteriorating
quality, nor does he seem to grasp that money has a broader function
than its role as a medium of exchange. In addition, he assumes that
money supply is neutral, is independent of demand, and yet should
grow in proportion to economic output. It is our intent to discuss
the falsity of those assumptions momentarily.
But first in writing The Theory of
Money and Credit, Ludwig von Mises made a special point of avoiding
a discussion of either inflation or deflation on the grounds that
there is a serious difference of opinion on its precise meaning,
and that therefore it would be unscientific to use such words "where
a sharp scientific precision of the words is desirable," in everyday
discussions of economic and currency policy.
Since his point was made (that he
could write an entire book on money and interest without referring
to the words inflation or deflation), he offered up his own definition
anyway. According to Mises (pp 272; The Theory of Money and Credit):
"In theoretical investigation
there is only one meaning that can rationally be attached to the
expression inflation: an increase in the quantity of money (in
the broader sense of the term, so as to include fiduciary media
as well), that is not offset by a corresponding increase in the
need for money (again in the broader sense of the term), so that
a fall in the objective exchange value of money must occur. Again,
deflation (or restriction, or contraction) signifies a diminution
of the quantity of money (in the broader sense), so that an increase
in the objective exchange value of money must occur. If we so
define these concepts, it follows that either inflation or deflation
is constantly going on, for a situation in which the objective
exchange value of money did not alter could hardly ever exist
So much is said in that paragraph
that one could go away for a year and learn all about the topic
of inflation, come back to this paragraph, and find new truths to
be revealed. Ludwig von Mises was ahead of his time, but he preceded
the currently unprecedented floating global fiat monetary experiment,
which began with Nixon's closing of the gold window, officially
I am personally certain his definition
of inflation in terms of the subjective exchange value of money
would have become more advanced were he alive and well today, and
much clearer in relation to our current predicament. Certainly,
the import and export of inflation/deflation is not new, but how
and whether the floating exchange rate between two countries using
credit money, and engaged in freer trade, affects the objective
exchange value of money must be (new).
To be sure, new economic theory will
probably emerge from this experiment showing how the government,
Fed, and entire global banking system achieved feats (good and bad)
never before accomplished in the history of mankind.
But this paragraph also has other
significance to us besides cleaning up our definition of inflation
It is an important point
that either inflation or deflation is constantly going on, and
even more important is Mises' observation that a stable purchasing
power for money is unattainable.
It is true, but good luck in trying
to measure it. Still, Wanniski's model seeks to fix the objective
exchange value of the dollar against gold. This way he hopes to
cure these "manifestations" of inflation and deflation, but by allowing
(actually promoting) growth in the monetary aggregates the model,
as he does, overlooks the causes of both. Monetarists believe that
the money supply is a neutral variable and that it is the rate of
interest, which causes inflation or deflation, thus completely disregarding
the quantity influence of money, which Wanniski embraces when it
And the odd thing about that contradiction
is Wanniski recognizes that deflation is a consequence of, or related
to, a mismatch between the demand and supply of money but he doesn't
seem to acknowledge otherwise the broad social and economic effects
of a growing money stock, preferring to hide beneath the assumption
that demand for money must be rising independently of its supply.
In asserting that it is someone's
job (like a central bank) to ensure a match between the demand and
supply of money it is assumed that the demand for money, and economic
demand measured by GDP are the same, and that they are independent
of the quantity of money supplied.
But that isn't quite correct. For
one, the calculation of GDP includes the interaction between expanding
monetary aggregates and real output, as well as net economic demand
resulting from the expansion in monetary aggregates. Didn't the
financial industry expand enormously over the past decade? Sure
it did because new markets developed that were necessary to stabilize
the massive inflation, and new ventures arose out of the reckless
supply of easy money for the taking. Entire industries were erected
from the era of easy money that specialized in creating demand for
The only thing that stimulates
the demand for a lot more money is a system that is based on an
Money in this economy is created
when someone wants to borrow for something, be it for business investment
or for consumption. The latter is not normally originated out of
the demand for money, but it surely adds to it. Not a moment after
spending the money, securities for sale, which will be bought by
one of the banks that deals with the Fed, or financed by the Fed.
Demand for that money will be determined by a suite of variables
independent of the decisions that went into its creation, such as
yield and quality. And it is money because it is fiduciary media
that is counted in the monetary aggregates.
But it isn't good money. It's increasingly
bad money, and there's too much of it.
After a thorough analysis of Professor
Wanniski's argument we have determined that there is agenda inherent
in his rhetoric. Just to clear the air, we do not have any personal
animosity towards Mr. Wanniski. Our animosity stems from the fact
that he operates under a disguise, and that there is a goal to his
work, which explains its inaccuracies.
Having reportedly met with Treasury
Secretary Paul O'Neill, and all the other names he likes to drop
in his writing, it is apparent to us that he is vying for a spot
as a player in whatever changes our global monetary pirates have
in mind. Were it not for that we would not need to refer to his
name, only his arguments.
Are Defaults Due to Inflation
His goal for instance explains (his symptoms?) why it is he defines
Japan's monetary plight in terms of the yen and all of the others
in terms of the dollar, rather than the Brazilian Real, Russian
Ruble, or the Zimbabwe dollar. Japan uses the dollar as its primary
monetary reserve as well.
I remember reading about
Russia's "inflation" crisis throughout the nineties, which makes
sense since the Ruble was in steep decline post the failed Soviet
full employment doctrine - communism.
Sure, dollars increasingly were becoming
the preferred choice, but in all cases, their currencies collapsed
as a consequence of a long running unsustainable inflation that
broke down. The result was increasing prices in terms of the most
common medium of exchange, and simultaneously, a preference for
a new medium of exchange.
Let us extend that by saying, hypothetically,
were the dollar foreign exchange rate to collapse under the weight
of excessive money supply, and the world went to a gold standard,
there would be inflation in terms of the dollar and deflation in
terms of gold, as was indeed the case throughout the seventies.
But since the dollar stayed on, our
perspective is through that medium. Should the dollar go away for
good, our future perspective will be from another currency. Thus
Wanniski is already assuming that these countries are going to become
Additionally, it isn't deflation
that is causing the rise in national default and bankruptcy rates.
It is indeed tempting to conclude, as does Mr. Wanniski, that both
must be symptoms of an oncoming deflation if not its cause. But
they are neither.
On the contrary, we argue that they
are a direct consequence of the aging monetary boom, which began
post Reagan, and a central bank policy that continues to set fire
to a faltering credit bubble, mature credit cycle, in particular,
bad investment policy.
In other words, it isn't
"not enough money" that is causing the problem but "too much money,"
Had monetary policy been kept neutral
throughout the past few years then there may have been deflation,
for various reasons, but it hasn't and consequently there is not
a single question in our minds that the cost of the failure of this
entire monetary experiment is going to be born by the dollar. Of
course the Federal Reserve and US Treasury will deny it, "they"
Let's get real here. Defaults are
not happening simply because money is now scarce, but because too
much money continues to chase after bad money (or
uneconomic ventures). Even today, while default rates are rising,
American financial institutions are lending more and more money,
thus fueling the poor decisions going into making loans. And as
David Tice says, the only reason that default rates are not higher
has increased the denominator in the loan default ratios, making
it appear that credit quality is not falling as quickly as it
really is, as newly extended loans don't default that quickly."
This of course begs the question
that if they ended their easy credit policies wouldn't the money
stock contract, as the consequence of rising default rates, which
would indeed bring on deflation?
Whoa horsy, what on earth could persuade
them to tighten credit, risk of bad loans? Didn't we just say that
they are easy, largely to keep those bad loans liquid? But
it is more that that.
The fact that a contracting
money stock is deflationary assumes that we are talking about
money when we discuss the US dollar.
What is Money?
But what if in the end the markets determine that the US dollar
is not really money? It is for all intents and purposes, because
it functions as a medium of exchange and unit of account. But Mises
says that credit money comes into being out of a temporary suspension
of full convertibility. While the dollar is exchangeable for anything
at the moment that does not mean there is a guarantee it will for
the foreseeable future. Full convertibility ended with Roosevelt
in 1934, and whether it is arguable or not, we contend that this
money represented by the dollar today came into being by a breach
of the constitution, if not the law.
Since then the only guarantee of
convertibility lies in the capability of the institutions charged
with our full faith and credit to guarantee all debtor contracts
that support the issue of this liability money. So that guarantee
depends on the Fed's viability, which in turn depends on how effectively
they can inflate, something, anything…
Ironically, one of the things that
can prevent the breakdown in the value of the dollar if only
temporarily, and at least in theory, is the belief that deflation
is setting upon the economy. If participants believe that the consequence
of the decade's monetary boom is deflation then they will act accordingly,
which, as we ought to know will invoke the old savings paradox,
where individuals seeking to protect themselves from deflation will
hoard cash balances and collectively cause a deflation.
The wildcard here today is in what
they will choose as money. The dollar is not fully convertible into
anything, plainly abundant and over-owned, is losing its investment
premium, has claims against it, and thus falls short in its role
as a store of value.
Our guess is that if the
US credit cycle is structurally mature then so is the value of
the dollar, in whatever role it played while the cycle was in
its boom phase. In other words, the dollar's fate is not only
tied to the stock market, but also to the credit cycle.
The bust sequence of monetary/credit
cycles since the gold standard was actually abandoned (in 1934)
has been bearish for the dollar, and we see no reason why this much
bigger bust is any different.
The one exception was the post WWII
recession, but then that was because Bretton Woods required the
world to own more dollars.
Which brings us back to the Polish
named economist. In The Deflation Monster, Jude Wanniski
quotes Mises and criticizes JM Keynes as if he were a proponent
of sound money himself, but nothing could be further from the truth.
In fact, it is the same trick that Keynes used in criticizing the
1929 Fed for being too tight. While it appeared that he was opposed
to the Fed and favored a gold standard, the truth was in the opposite
of both illusions.
Jude Wanniski and Robert Mundell
are proponents of fixity, or fixed exchange rates. They advocate
a variation on the Bretton Woods international monetary standard
where the United States would control but not monopolize the agreement.
That system was unsound, as is any monetary system contrived by
the State to oppose market forces. Near the end of his article,
Wanniski says that:
"In a new
(monetary) regime, we might expect the United States to get more
say in its management than other member states, but not a monopoly
power, which is what it had in the Bretton Woods system. I believe
Mundell could design such a system between breakfast and lunch,
as he has been thinking about it for decades."
I'm certain he has.
Thus, his idea is for an immoral
gold standard, much like the one that Keynes helped develop the
Bretton Woods system around. Although he writes that he is bullish
on the price of gold, he is not bullish on what gold really stands
for. If he were he wouldn't weigh down the sound money principle
with more policy.
Our suspicion of Mr. Wanniski
is in no small part ground in the convenience that declining gold
prices present to his argument.
Indeed I wonder how smart his deflation
argument would look if it were true that the world's central banking
cartels have been manipulating the dollar/gold ratio? That one tiny
truth would have to put him in the inflation camp faster than you
could say I. What then would be his argument for deflation, or anyone's
for that matter?
Wanniski Conveniently Doesn't
So what can we make of current circumstances, where the nation's
most revered and popular economists seem to be engaged in some form
Make no mistake; Wanniski is a Statist
and an enemy to gold in its role as guardian of the sound money
doctrine. But his argument is undoubtedly convenient for some interests
today. Interests that want to persuade you of the strong dollar,
which is the only way they can defer the inevitable… inflation breakdown.
What he wants for gold is already
happening, according to GATA, but has been taken advantage of. If
this proves to be true (it is true but proving it is another thing)
then clearly there is not a little hole in his arguments (which
we think might look rather dumb in hindsight, someday).
Ludwig von Mises, for instance,
knew full well that the principle of sound money and monetary
"policy" are mutually exclusive.
Wanniski is blind to that concept.
Moreover, John Keynes, an advocate and early designer of the Bretton
Woods monetary system (along with Irving Fisher), preached that
the supply of money must keep pace with output. Our Polish economist
too preaches this nonsense, which disregards the monetary affects
on the computation of aggregate demand, as discussed earlier.
Nonetheless, while completely disregarding
the principle of sound money (as defined by Mises) throughout the
paper, Wanniski proceeds to quote Mises in the context of one of
his rejections of policy altogether in what must be utter ignorance
about Mises' views on the subject:
under the delusion that the evils caused by inflation could be
cured by a subsequent deflation… but the statesmen who were responsible
for the deflationary policy were not aware of the import of their
action. They failed to see the consequences which were, even in
their own eyes, undesirable, and if they had recognized them in
time, they would not have known how to avoid them." - Ludwig von
Allow us to complete Mises' thoughts
on the subject of State and money from his Theory on Money and Credit:
principle is so much as admitted that the state may and should
influence the value of money, even if it were only to guarantee
the stability of its value, the danger of mistakes and excesses
immediately arises again."
One of the biggest ironies as pertains
to Wanniski quoting Mises is that Supply Side doctrine precludes
the individual as a primary actor in the economy, while he is the
primary actor in Austrian economic doctrine. According to Wanniski:
"In a supply
side model, it is not consumers but producers of goods - those
who supply them to the marketplace - who are the primary actors."
This markedly alters one of the main
properties that have historically made money what it is, by making
its role as a store of value secondary to its role as a medium of
exchange, for instance. Consider what Mises says on credit money:
"Yet credit money is not merely
an acknowledgement of indebtedness and a promise to pay. As money,
it has a different standing in the transactions of the market.
It is true that it could not have become a money substitute unless
it had constituted a claim. Nevertheless, at the moment when it
became actual money - credit money - (even through a breach of
law), it ceased to be valued with regard to the more or less uncertain
prospect of its future full conversion and began to be valued
for the sake of the monetary function that it performed. Its far
lower value as an uncertain claim to a future cash payment has
no significance so long as its higher value as a common medium
of exchange is taken into account."
Doesn't it all make sense that if
our money, being credit money, has no value as an uncertain claim
to a future cash payment or conversion that it is of prime importance
that the state continues to promote its value as a medium of exchange?
Isn't it of prime importance
that the credit cycle, stock market boom, and full employment
doctrine don't stop so as to put into question the dollar's convertibility?
But then if they continue, great
right? Wrong. If the stock market bubble/inflation is the result
of growth in the money supply over the nineties (duh) under the
auspices of a full employment doctrine then the result will ultimately
be the same as it always has been. The longer goes the misallocation
of resources through a mostly artificial boom, the greater will
be the corrective forces required to re-employ the economy.
Unfortunately, the booms this century
and indeed often through history, have been of monetary origin,
or the equivalent of debasement. The only thing standing in front
of the crystallization of this fact is the Treasury and Supply Side
For doesn't Supply-Side doctrine
fit conveniently into our current monetary predicament, and doesn't
it fit nicely with our belief that we live in a capitalist society?
More than perhaps even the highly regarded Jude Wanniski will ever
know. For it must be pure ignorance on the professor's part not
to understand that Austrian economic theory is based on (individual)
human action as the core economic variable, a position that seems
diametrically opposite to the one above.
The Inflation Trap
Some time ago we wrote a piece entitled "There
is No SafeHaven," where we concluded that the Fed is in
an inflation trap, and proceeded to detail seven reasons. Briefly
here they are (for a better understanding of each, please refer
to above link):
- The Fed's sponge is politically
incorrect, and fundamentally disabled.
- Inflation has always existed,
but nobody can see it.
- The new dollar paradigm has made
the US dollar vulnerable to tight money.
- Vested interests in the cancellation
of all debts: U.S. is a debtor nation, as opposed to a creditor
nation such as Japan.
- The Fed itself no longer controls
the money supply. · The politics of the dollar are stressing the
strong dollar policy.
- Lender of last resort model guarantees
all debtor contracts.
I think our arguments are more advanced
today, but our conclusion is the same, that deflation in the United
States is utter nonsense, and impossible. We believe this to still
be true and in fact many of the points above have now intensified
along with our view that the current deflationary conundrum has
been brought on by unsustainable and easily reversible policy that
is designed to actually control the massive inflation agenda.
The one where we have proven wrong
so far is that the politics of the dollar stressed out a year ago.
Clearly, we have learned since then how powerfully vested interests
are shared across the border. But a market is a market, and we may
be dealing with forces bigger than just the United States Treasury
or Fed, but the bigger they are the harder…
Let us add one more to our list.
This one is speculative but quite logical. We believe that when
it is clear that the US credit cycle is going to contract individuals
and investors will deem that the dollar does not qualify as money,
provided they are allowed to make the choice, and eventually even
if they are not.
Sooner or later the dollar
is going to fall from grace as a global international reserve
currency, in our view, as a consequence of the illegal devaluation
required of a credit currency in a secular bust.
Thus (Robert), I do not think that
it will come down to which will be a greater force, deflation or
the foreign repatriation of deposits, but what will the primary
actor in our economy choose as money when the credit cycle goes
indisputably into reverse.
I sincerely hope you understand inflation and deflation better after
reading this. At least we do after writing it.
Despite a cogent non-deflationary
explanation for many symptoms of deflation today it is likely that
the deflation side of the debate will survive. As Mises says, the
forces of inflation and deflation are always going to be there.
I wasn't always as convinced as today
about the ultimate inflation breakdown. Prior to 1998 and in another
life I was in the deflation camp. It was the events subsequent where
it became apparent that the nation's obsession with deflation was
going to produce what is properly called an inflation breakdown.
An inflation breakdown may
manifest in deflation or it may manifest in the money, in which
case Keynesians would label it stagflation. It is a breakdown
in the inflation agenda responsible for undermining the sound
The period in between 1971 and 1980
should be properly dubbed an inflation break down, not simply inflation,
and especially not the Keynesian term "stagflation." We have had
inflation forever. Fact.
Certainly a reversal of the credit
cycle may indeed bring about a contraction in the so called money
stock, but simultaneously, if the value of the dollar is as we cite
largely a function of the viability of the US credit cycle then
the consequences ought to show up sooner or later in the exchange
value of the dollar against other things that better qualify as
money, which perhaps don't have a claim against it, and especially
once the credit cycle is deemed a bust.
Deflation? They wish. US Dollar governors
(O'Neill and friends) are working hard to make you believe in this
economy, and at the moment, in its recovery. Meanwhile the global
banking establishment is working hard to defer the consequences
of the unprecedented late nineties' malinvestments, particularly
the resultant bad loans.
Their efforts, however, largely continue
to worsen the underlying problem as well as drag out the corrective
forces like Chinese water torture, obviously in the belief that
they can re-ignite the full employment doctrine.
Who knows, maybe they can, but it
can't last for various reasons we normally cite.
So, when Professor Wanniski says
that deflation will result in a declining monetary standard he is
plainly wrong. Inflation results in a declining monetary standard
when it breaks down.
By saying that deflation is a decline
in the monetary standard Wanniski overlooks the savers choice in
deciding money by not differentiating between its role as a medium
of exchange and its role as store of value. It is no surprise he
does this since supply side doctrine assumes that the producer is
the primary actor. But at the same time he endorses our argument
with respect to the quality of the money, unwittingly.
And we argue that it is quality (defined
in his way) indeed that will determine what the individual saver
will choose, and in the end, producers have no use for a medium
of exchange that isn't accepted by the individual either. Furthermore,
simply by offering up a system of money similar to the Bretton Woods
agreement, he infers that the money today does not stand on its
own. It needs government help.
We would agree that it does not stand
on its own, but refuse the government's help in deciding for us
where we should keep our savings.
In lieu of this solution
alone, we suggest that it must be clear right up to Paul O'Neill's
suite that the money is just no good.
If the inflation ultimately leads
to a new monetary system, or standard, then we will have deflation.
We cannot have deflation
until we have learned to despise inflation.
It will be the change to new money
that will create deflation and it will be a good thing in the long
run, so long as the money is not a new monetary regime such as the
one presented by Professor Jude Wanniski and modeled after Bretton
Anyhow, all of this cannot end well
for the economy indeed, but worse, it cannot end well for the dollar.
Money supply can contract while the value of the currency
is in decline. It did this August, briefly, while the dollar was
in descent. Furthermore, if the objective as well as subjective
exchange value of the dollar can rise while it is growing in quantity
why on earth could it not decline while it is falling in quantity.
And it shouldn't need to be even
said that anyone working for the government or financial sector
is unlikely to say the money is bad, for they are in the business
of creating it. It follows then if we are correct that since deflation
is bullish for the currency, in that it manifests in a rising exchange
value against other things, it is vital for policymakers to ensure
the deflation argument dominates expectations, which is how they
attack inflation expectations.
Promoting the concept of deflation
is a policy benefit that we can directly link to the Federal Reserve's
interests, and thus deflation arguments even if correct ought to
be suspect from an analytical viewpoint. Remember, the idea and
agenda is to continue to inflate, but there is no way to do that
effectively if inflation expectations rise.
Thus there is deflationary bias in
all of their data, which is why when we hear reports that crude
inventories are building, they are interpreted as potentially deflationary
rather than a reflection of inflation expectations. The year 2001
has been a success for Fed policy in choking off inflation expectations,
but it has not and cannot be an instrument of deflation. That is
Near the end of his document, Jude
Wanniski says, "an obsession with inflation can be counted upon
to bring deflation." But so too can an obsession with deflation
bring about inflation. Jude Wanniski is not who he appears to be.
He is, in our estimation, a reincarnation of John Maynard Keynes;
also a generalist with little real economic depth. And his goal
is to help Mundell write the new global monetary order perhaps so
that the United States does not face an illegal devaluation.
However, so far deflation is just
a bogeyman. The rate of growth in money supply continues to astound
us, and the only sign of deflation is in some of the shared symptoms
that have resulted from a confluence of market and managed events.
If we are wrong and deflation does
occur in dollar terms then it is because either the market chooses
the dollar as money when the credit cycle implodes, or policymakers
rig the dollar through a global monetary system requiring all foreign
participants to give up some of their right to full convertibility.
Nonetheless, this may be good for
gold prices if gold becomes an anchor in the short term, but it
isn't good for capitalism, liberty, or prosperity (excepting the
few rigging the game).
Moreover, we don't think it can work
because it would require an independent audit of the nation's gold
reserves. On the contrary, we are confident that some day the O'Neill
Dollar, Greenspan Fed, and the Wanniski Deflation will all become
the butt of good ethnic and/or economic humor.
The survival of capitalism depends
Edmond J. Bugos
- "Thus the sound
money principle has two aspects. It is affirmative in approving
the market's choice of a commonly used medium of exchange. It
is negative in obscuring the government's propensity to meddle
with the currency system." - Mises, on the principle of sound
money, pp454, the Theory of Money and Credit
- The criticism
Mises cited by some groups against sound money and liberty at
the time was that it was negative in its definition.
- "The central
element in the economic problem of money is the objective exchange
value of money, popularly called its purchasing power. This is
the necessary starting point of all discussion; for it is only
in connection with its objective exchange value that those peculiar
properties of money that have differentiated it from commodities
are conspicuous. This must not be understood to imply that subjective
value is of less importance in the theory of money than elsewhere.
The subjective estimates of individuals are the basis of the economic
valuation of money just as of that of other goods. And these subjective
estimates are ultimately derived, in the case of money as in the
case of other economic goods, from the significance attaching
to a good or complex of goods as the recognized necessary condition
for the existence of a utility, given certain ultimate aims on
the part of some individual. Nevertheless, while the utility of
other goods depends on certain external facts (the objective use-value
of the commodity) and certain internal facts (the hierarchy of
human needs), that is, on conditions that do not belong to the
category of the economic at all but are partly of a technological
and partly of a psychological nature, the subjective value of
money is conditioned by its objective exchange value, that is,
by a characteristic that falls within the scope of economics."
An excerpt from The Theory of Money and Credit; Part Two,, chapter
7 by Ludwig von Mises
- Jude Wanniski
is the president of www.Polyconomics.com, a website dealing with
political and economic topics. His career included journalism
for the Wall Street Journal, and is known for his book "The Way
the World Works," which was the birth of supply side doctrine
that some know as Reagan-omics.
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