Does Keynesianist Money Illusion works? evidence says yes

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RayLopez99

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Apr 19, 2009, 2:21:06 PM4/19/09
to
I authored the thread here: http://mises.org/Community/forums/p/7511/127628.aspx#127628

But I want your feedback too, so I repeat this thread in this forum.

Read the below and vote--does Keynesianist Money Illusion work? The
evidence says yes, whether we like it or not (yes I am a gold bug!)

RL

Prior to reading this thread, please see this thread on Say's Law for
context: http://mises.org/Community/forums/p/7410/127588.aspx#127588

Pay particular attention to my posts. I repeat a salient passage from
that thread here:

"These are fundamental and rather simple distinctions. Keynes believes
"animal spirits" cause endogenous ([sic] exogenous) demand shocks.
Austrians, and Say, argue that endogenous demand shocks are impossible
in a truly free market economy, with the exception of either
government interventions or natural disasters and such. "

The followup to that thread is to discuss the question posed by both
Keynesianism and the Austrian School (which, as I posited in the prior
thread, seem to agree that Aggregate Supply (AS) does not change, but
Aggregate Demand does change): how to get Aggregate Demand (AD) "back
to normal" after such a shock (caused by government, natural
disasters, or, my favorite, "and such")?

We'll leave the Austrian reply for another thread (which I think
involves some hocus-pocus involving how the gold standard and a fixed
money supply magically either prevents demand shocks and/or abolishes
the business cycle and/or magically gets AD back to normal). In this
thread, I would like to discuss the Keynesian solution to getting AD
back to normal, which involves the technique of the "helicopter drop"
or "Money Illusion".

For those of you that have never taken a university course in
economics, which, sadly, seems to be the majority, I will give a brief
primer of the "helicopter drop" technique for increasing society's
Aggregate Demand. Suppose due to government intervention, natural
disasters, or "and such" (panic? Joker's Wild), somehow AD falls. We
are in a recession. People are hoarding money. Nobody wants to spend
money because they are afraid, or think they can buy goods later for
less money, or some other reason. Ben Bernanke gets into a Boeing
CH-47 Chinook (Model 234LR, civilian version), loaded with 12 tonnes
of paper money, and begins dropping dollar bills onto denizens in
major metropolitan regions. How did he get that money? Not by working
for it--it was just created overnight in the Bureau of Engraving and
Printing. It's fiat money not even backed by prior US government
committments but brand new money. He does this 100 times in 100 major
cities. No, make that 1000 times. No, make that a million times. What
happens? People get the money, and some of them spend it. This
stimulates the economy. The hoarding spell is broken. AD begins to
rise again. Soon, it's "business as usual", recession over.

What's wrong with this picture? First, Ben himself would not spread
the cash--it would be some government department, probably the US
military, so they would use a military CH-47. More fundamentally,
people have argued (conservative economists, yes, but Austrians? I'm
curious as to their position) that this is a form of "Money Illusion",
and that people will, after the n-th drop, figure out this money is
being printed overnight and is rapidly becoming worthless. The
criticism is a good one, but there's two rebuttals by Keynes: first,
where is "n-th"? Is it after the first drop? The 99th drop? The
999,999th drop? If it's the first drop, then Money Illusion (MI) does
not work--the helicopter drop will have to effect on AD. If it's the
99th drop, MI does work initially, but over time it's attentuated. If
it's the 999999th drop, then MI works fine--by the time the people
figure out they have been "duped", then the economy will be back to
normal, and perhaps at a cost of some future inflation and voter/
citizen ire, it's "business as usual" and MI has worked (although you
can argue it may not work again in the future, once people cotton onto
this technique--this essentially was the point made by proponents of
the "Rational Expectations" school of the 1980s).

Unlike the Austrians with their theories, the Keynesians actually have
proof that Money Illusion works (again, I'm not 100% sure on what the
Austrians believe with respect to MI or anything else--like the French
philosophers like Jacques Derrida, they are hard to pin down). Two
pieces of evidence: stock splits, and university experiments in
sociology labs involving student volunteers and real money.

With stock splits, it has been observed that a 2-for-1 stock split
will almost always result in the stock price going up the next day--
when logically it should not, on average, change much. This is a form
of money illusion. I have seen this work with people I know. And
intuitively people like it when they have "double the shares they had
yesterday". Not logical, but Daniel Kahneman won the Nobel Prize in
Economics for exactly this sort of thinking.

With numerous university experiments, involving student volunteers and
real money (cash prizes) researchers have shown MI exists, see, for
example, "Money Illusion and the Market", Jean-Robert Tyran, Science
24 August 2007 317: 1042-1043 ["Individuals often pay more attention
to price tags than to real value. Evidence shows that this may also
have important effects on markets."]

Conclusion: Keynesianism works, much as we hate to admit it. Money
illusion, a central tenant of Keynesianism, works.

More information on MI: http://en.wikipedia.org/wiki/Money_illusion

James A. Donald

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Apr 20, 2009, 6:06:26 AM4/20/09
to
RayLopez99 <raylo...@gmail.com> wrote:

> I authored the thread here:
> http://mises.org/Community/forums/p/7511/127628.aspx#1
> 27628

You assume that Say's law is false - that aggregate
demand is likely to differ substantially from aggregate
supply.

Consider the present crisis. Aggregate demand has
fallen in nominal terms nine percent, or eleven percent,
depending on how one measures and defines it.

If potential supply was what it should be, then indeed
the Keynsian account is true.

But is potential supply what it should be? Looks to me
that runaway socialism and a resulting Galt strike has
caused a collapse of supply.

If potential supply is what it should be, then we should
be seeing broad deflation. For example, car dealers
should be cutting prices.

Of course they are not cutting prices, because the fewer
cars they make, and the fewer cars they sell, the more
they will be bailed out - we have gone beyond paying
farmers to not grow corn, to paying car makers to not
make cars.

If we look at the cpi, you will notice it is rising in
some product groups and falling in others. It is rising
in areas, such as new cars, where you would expect
runamuck socialism to reduce supply.


--
----------------------
We have the right to defend ourselves and our property, because
of the kind of animals that we are. True law derives from this
right, not from the arbitrary power of the omnipotent state.

http://www.jim.com/

RayLopez99

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Apr 20, 2009, 11:12:27 AM4/20/09
to
On Apr 20, 6:06 am, "James A. Donald" <jam...@echeque.com> wrote:

> RayLopez99 <raylope...@gmail.com> wrote:
> > I authored the thread here:
> >http://mises.org/Community/forums/p/7511/127628.aspx#1
> > 27628
>
> You assume that Say's law is false - that aggregate
> demand is likely to differ substantially from aggregate
> supply.

James A. Donald--I could use your help at Mises.org. I don't believe
AS necessarily has not changed--this was a Mises.org poster's position
on the Austrian School. I took him at his word. I thought it was
strange that he would make this admission, see here:
http://mises.org/Community/forums/t/7410.aspx?PageIndex=3

I repeat the salient part of this post below. But I would greatly
appreciate your insight (I am not an economist, and you seem to be)

RL

http://mises.org/Community/forums/t/7410.aspx?PageIndex=3

RayLopez replied on 04-19-2009 11:29 AM

You {THIS IS ANOTHER POSTER, NOT ME--RAYLOPEZ} said: These are


fundamental and rather simple distinctions. Keynes believes "animal

spirits" cause endogenous demand shocks. Austrians, and Say, argue


that endogenous demand shocks are impossible in a truly free market
economy, with the exception of either government interventions or
natural disasters and such.

EDIT: I misspoke - Demand shocks caused by government interferences
and phenomena such as natural disasters and epidemics are exogenous
demand shocks

I {RAYLOPEZ} say: You also seem to have confused AS and AD. In any
event, you made an important admission when you say: Austrians, and


Say, argue that endogenous demand shocks are impossible in a truly
free market economy, with the exception of either government
interventions or natural disasters and such.

First, these three "exceptions" swallow the (absurd) rule. "and
such"? Meaning? Second, you do not address the fundamental
question: given that even the Austrians and Say admit there are
"exceptions" to the rule, including "government interventions",
"natural disasters" and "and such" (which might include a human
induced natural disaster, such as greed caused by hubris, aka the
banking crisis?, but that's another question that we need not address
now), the central question is this: can Keynesianism over the short
term move AD to get it "back to where it was"? Keynesians would argue
yes, through the technique of the so-called Money Illusion (a term of
art, I trust you know what that is). The Austrians, by your rule, are
not clear as to how do so this, from what I could tell of their
literature, except by hoping that by adopting a gold standard that
magically things will either get back to normal (if your definition is
accepted--I am surprised that you conceed AS will not change*), or,
will never get out of normal (some of the literature that I've read,
which implies the business cycle will be abolished if we adopt the
gold standard--which contradicts your "government interventions",
"natural disasters" and "and such" as affecting the AD).

I will, if I don't get censored by the 'moderator' (a Mises subscriber
volunteer I'm sure), start a separate thread on Money Illusion.

"Thanks" for the conversation. I learned something about the Austrian
school--they are more bizarre than the Jonestown devotees in some
ways. How does that Kool-Aid taste, Austrian school?

RL

* IMO you made a damaging admission by saying AS is inflexible. The
revolution called "Supply Side" during the 1980s made a point that
given incentives, the AS could be changed so that my previous reply
would hold--given a change in AD, so that, say, society wants less of
everything at a given price, that AS could adjust so that more is
produced to give the same equilibrium point, Q. Graphically, simply
draw two upward sloping parallel lines (AS, AS') and two downward
sloping, parallel, AD lines (AD, AD'). The parallelogram represents
the area of interest. Note the top of the diamond is Q0 (horizontal
axis, representing quantity), prior to a shock in AD. The bottom of
the diamond, vertically, that is at the same Q, represents the new
quantity that we want to get to; while the 'left'/'west' vertice
represents the point when there is a decrease in AD (AD shifts to the
left, down). How do we get to that 'bottom' diamond point, to get the
same quantity as before the change in AD? Just look at the curves--
increase AS so now the new intersection point is not the left corner
of the diamond, but the bottom. That's essentially what the Supply
Siders claimed. No need to fiddle with AD--incentivize people to
change AS. But, I am not going to make your case for you. You (and
the Austrians and Say) have conceeded AS does not change. You have
made your bed now you must lie in it. And Keynes and the anti-Supply
Siders do make a good point (that you have implicitly accepted) that
AS cannot easily change. This goes to the question of how quickly
people can "retool". The Keynesians accept that retooling is
expensive, futile and doesn't really work--and there is some evidence
to support it. Better, say the Keynesians, to fiddle with AD with
techniques such as Money Illusion (aka "helicopter drop"). More on
that in a separate thread.

DanB

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May 8, 2009, 12:23:21 PM5/8/09
to

Hello Ray, James...

First I would say that premises need to be accounted for. We don't
operate with a fiat money, it is credit money. So Bernanke's helicopter
drop would be a sudden break from the present paradigm.

In a credit money system there is no mechanism to create more money and
stimulate the purchases of frying pans when the fed runs out of ammo,
our present condition. It is why the price of automobiles don't fall on
the lot, the banks own these vehicles and don't want to take the loss,
(do the mark to market thing). In this system the only way to create
excess money is if government uses the fiat mechanism and spends. The
stimulus package amounts to 3% of GDP and is dwarfed by total credit
market debt. So, it is just not happening.

If anything, the bailout will only worsen this situation as it only
shores the reserves of the banking system. It does not create market
money, but it does support the level of total credit market debt, the
very burden that is creating a deflationary pressure.

In this system the real value of money comes from the ability to produce
from investment, and create a revenue stream that exceeds the cost of
debt maintenance. It is a system that only works if there is more money
created from debt into the future.

From what I understand of the Austrian School, they do not condone a
classical 'gold standard' money. These moneys have been in late history
a note creation system of fractional lending. There are alway more notes
in circulation than the underlying metal they are said to represent. The
fundamental difference is that the bank that over lends does not have a
fed that can bail them out. So the failure mechanism is much different
in result, but not in cause.

In a commodity money system there is no failure mechanism of the money
itself. Booms and bust become self limiting because without a mechanism
to create money from thin air, bubbles are impossible and bankers are
unnecessary.

A favorite paper:
<http://mises.org/money.asp>

Is it different this time? I would think so and we are already seeing
the signs. Commodities are still elevated in a ten year span while the
assets that so much money is based on, housing, factories, malls, are
sinking. China understands this imbalance and why they are out there
buying up every source of limited commodities they can. I think we are
only seeing the beginning of 'stress' on the banking system.


Best, Dan.

James A. Donald

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May 9, 2009, 12:51:07 AM5/9/09
to
--
On Fri, 08 May 2009 09:23:21 -0700, DanB <a...@some.net>
wrote:

> In a credit money system there is no mechanism to
> create more money and stimulate the purchases of
> frying pans when the fed runs out of ammo, our present
> condition. It is why the price of automobiles don't
> fall on the lot, the banks own these vehicles and
> don't want to take the loss, (do the mark to market
> thing).

Yet houses *are* being marked to market, creating a
crisis as a vast pile of securitized debt built on top
of house prices is now not marked to market, even though
the underlying assets have been.

The reason that houses are being marked to market is
that the people (mostly Mexicans) who purchased them at
the top of the market are not getting all that much in
bailouts, while the car makers are getting fairly
substantial bailouts. When push comes to shove,
"protected minorities" get considerably less protection
than main street union bosses, and main street union
bosses considerably less protection than incompetent
wall street financiers.

> If anything, the bailout will only worsen this
> situation as it only shores the reserves of the
> banking system. It does not create market money, but
> it does support the level of total credit market debt,
> the very burden that is creating a deflationary
> pressure.

But this presupposes that there is deflationary
pressure: The core inflation rate remains steady as she
goes, indicating a recession more akin to that described
by Ayn Rand than that described by Milton Keynes.

> Commodities are still elevated in a ten year span
> while the assets that so much money is based on,
> housing, factories, malls, are sinking. China
> understands this imbalance and why they are out there
> buying up every source of limited commodities they
> can. I think we are only seeing the beginning of
> 'stress' on the banking system.

The Chinese have come to the conclusion that relying on
US fiat money is a bad idea, largely because it has
become apparent that the US banking system is regulated
by crooks - the same harvard crowd that ran Russia into
the ground, giving it a system of crony capitalists.

They are moving in two directions: Buying commodities
as money, such as copper, silver, and gold, and making
bilateral exchanges of fiat money with customers and
suppliers - diversified commodity money and diversified
fiat money - a rational response to the realization that
corrupt regulators and irresponsible politicians expose
people who use the US dollar to considerable risk.

RayLopez99

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May 9, 2009, 11:24:33 AM5/9/09
to
On May 8, 12:23 pm, DanB <a...@some.net> wrote:
> Hello Ray, James...
>
> First I would say that premises need to be accounted for. We don't
> operate with a fiat money, it is credit money. So Bernanke's helicopter
> drop would be a sudden break from the present paradigm.

Yes, I agree nobody has done a credit expansion using fiat money from
a helicopter.

>
> In a credit money system there is no mechanism to create more money and
> stimulate the purchases of frying pans when the fed runs out of ammo,
> our present condition. It is why the price of automobiles don't fall on
> the lot, the banks own these vehicles and don't want to take the loss,
> (do the mark to market thing). In this system the only way to create
> excess money is if government uses the fiat mechanism and spends. The
> stimulus package amounts to 3% of GDP and is dwarfed by total credit
> market debt. So, it is just not happening.

3% is still a lot, but your point is well taken, that for now there's
not much fiat money creation. But the Fed is acting as a lender of
First Resort, usurping the role of banks. This is not healthy. Might
this led to another crisis, where we'll resort to more than 3%
stimulus using freshly printed (fiat) money? I hope not, but that's a
scary thought.

>
> If anything, the bailout will only worsen this situation as it only
> shores the reserves of the banking system. It does not create market
> money, but it does support the level of total credit market debt, the
> very burden that is creating a deflationary pressure.
>

Maintaining the status quo will worsen things is your position it
seems. Perhaps. And this might lead to a scenario where hyper-
inflation is the only way out. Whether by "money illusion" (initially
in the hyperinflation), or, more long term, an "inflation tax" that
hits all net savers and bails out all net debtors.

> In this system the real value of money comes from the ability to produce
> from investment, and create a revenue stream that exceeds the cost of
> debt maintenance. It is a system that only works if there is more money
> created from debt into the future.
>
>  From what I understand of the Austrian School, they do not condone a
> classical 'gold standard' money. These moneys have been in late history
> a note creation system of fractional lending. There are alway more notes
> in circulation than the underlying metal they are said to represent. The
> fundamental difference is that the bank that over lends does not have a
> fed that can bail them out. So the failure mechanism is much different
> in result, but not in cause.

Yes, I agree. Same result but different paths to get there.

>
> In a commodity money system there is no failure mechanism of the money
> itself. Booms and bust become self limiting because without a mechanism
> to create money from thin air, bubbles are impossible and bankers are
> unnecessary.

This is the Austrian position I take it, not yours. It's nonsensical
to a degree--what is "self limiting"? Global bankruptcy is also a
"limit".

>
> A favorite paper:
> <http://mises.org/money.asp>
>
> Is it different this time? I would think so and we are already seeing
> the signs. Commodities are still elevated in a ten year span while the
> assets that so much money is based on, housing, factories, malls, are
> sinking. China understands this imbalance and why they are out there
> buying up every source of limited commodities they can. I think we are
> only seeing the beginning of 'stress' on the banking system.
>

Do you think the population increasing from 6.7 to 9 billion in the
next 40 years will help commodoties? I think so.

RL

RayLopez99

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May 9, 2009, 11:14:48 AM5/9/09
to
On Apr 20, 6:06 am, "James A. Donald" <jam...@echeque.com> wrote:
> RayLopez99 <raylope...@gmail.com> wrote:
> > I authored the thread here:
> >http://mises.org/Community/forums/p/7511/127628.aspx#1
> > 27628
>
> You assume that Say's law is false - that aggregate
> demand is likely to differ substantially from aggregate
> supply.
>
>
> If we look at the cpi, you will notice it is rising in
> some product groups and falling in others.  It is rising
> in areas, such as new cars, where you would expect
> runamuck socialism to reduce supply.
>
> --

That's interesting, that AS (Aggr. Supply) indeed has matched AG (Ag.
Demand). If your data are correct, it means that what we experienced
last fall was just a classic "panic" akin to what was suffered in the
19th century and that in fact AD = AS, and that's why we have a
crisis. In fact then, there is no drop in AD while AS stays the same--
both have dropped. Why? Perhaps people realized we are in a bubble,
and stopped demanding (and supplying) the same amount of goods as
before. We are in retrenchment.

Also consider that NAIRU (the natural rate of unemployment) is
estimated by some to now be two points higher than before--something
like 6 or 7%. This shows that demand and/or supply have permanently
changed due to this crisis.

There's only one thing wrong with the above: it's difficult to prove.

RL

DanB

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May 9, 2009, 12:54:42 PM5/9/09
to
James A. Donald wrote:
>
> The Chinese have come to the conclusion that relying on
> US fiat money is a bad idea...

Media hype and saber rattling. The numbers don't support it.
<http://www.treas.gov/tic/mfh.txt>

Modern money is not fiat, it is 'credit money'. This is how it is created:

<http://lakeweb.com/money/MMM.pdf>

This guy wrote an excellent article:

<http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/>

Best, Dan.

DanB

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May 9, 2009, 1:17:58 PM5/9/09
to

Hi Ray,
I know your name from somewhere in the past!...

RayLopez99 wrote:
> On May 8, 12:23 pm, DanB <a...@some.net> wrote:
>> Hello Ray, James...
>>

>> The
>> stimulus package amounts to 3% of GDP and is dwarfed by total credit
>> market debt. So, it is just not happening.
>
> 3% is still a lot, but your point is well taken, that for now there's
> not much fiat money creation. But the Fed is acting as a lender of
> First Resort, usurping the role of banks. This is not healthy. Might
> this led to another crisis, where we'll resort to more than 3%
> stimulus using freshly printed (fiat) money? I hope not, but that's a
> scary thought.

I'm not saying it can't happen, I just don't see it yet. So far the fed
is behind the curve. And the 'lending' the fed is doing...


>
>> If anything, the bailout will only worsen this situation as it only
>> shores the reserves of the banking system. It does not create market
>> money, but it does support the level of total credit market debt, the
>> very burden that is creating a deflationary pressure.
>>
>
> Maintaining the status quo will worsen things is your position it
> seems. Perhaps. And this might lead to a scenario where hyper-
> inflation is the only way out. Whether by "money illusion" (initially
> in the hyperinflation), or, more long term, an "inflation tax" that
> hits all net savers and bails out all net debtors.

The bailout is a shoring of banking reserves. This is not money in
circulation, what creates inflation. If the banking system does not
lend, 'real' money is not created.

>> In a commodity money system there is no failure mechanism of the money
>> itself. Booms and bust become self limiting because without a mechanism
>> to create money from thin air, bubbles are impossible and bankers are
>> unnecessary.
>
> This is the Austrian position I take it, not yours. It's nonsensical
> to a degree--what is "self limiting"? Global bankruptcy is also a
> "limit".

I don't know that this is just Austrian. It is certainly not from the
Chicago school. :) I think the likes of Friedman apologists for the
banking system.

How can there be a global bankruptcy with a system where money can not
be destroyed, short of every one staying home and refusing to eat and work?

> Do you think the population increasing from 6.7 to 9 billion in the
> next 40 years will help commodoties? I think so.

I look at it where the limits of commodities create the future. We can
no longer treat commodities as limitless. Oil is fundamental in
production and distribution and it is now an immediate concern.

I don't think this planet can support so many without limitless
resources. I'm getting older but I think my son will see a very
different world than we have gotten use to.

Best, Dan.

Oh yea, do see that paper I posted for James.

<http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/>

RayLopez99

unread,
May 10, 2009, 3:47:27 PM5/10/09
to
On May 9, 1:17 pm, DanB <a...@some.net> wrote:
> Hi Ray,
> I know your name from somewhere in the past!...
>

Have we done battle before?

> I'm not saying it can't happen, I just don't see it yet. So far the fed
> is behind the curve. And the 'lending' the fed is doing...
>

Yes, so far I think you're right.

> The bailout is a shoring of banking reserves. This is not money in
> circulation, what creates inflation. If the banking system does not
> lend, 'real' money is not created.

I see, yes as for now no money in circulation, so no inflation.

> >> In a commodity money system there is no failure mechanism of the money
> >> itself. Booms and bust become self limiting because without a mechanism
> >> to create money from thin air, bubbles are impossible and bankers are
> >> unnecessary.
>
> > This is the Austrian position I take it, not yours.  It's nonsensical
> > to a degree--what is "self limiting"?  Global bankruptcy is also a
> > "limit".
>
> I don't know that this is just Austrian. It is certainly not from the
> Chicago school. :) I think the likes of Friedman apologists for the
> banking system.

I saw your reference to Steve Keen's DebtWatch, and have read it. My
comments below.

>
> How can there be a global bankruptcy with a system where money can not
> be destroyed, short of every one staying home and refusing to eat and work?
>
> > Do you think the population increasing from 6.7 to 9 billion in the
> > next 40 years will help commodoties?  I think so.
>
> I look at it where the limits of commodities create the future. We can
> no longer treat commodities as limitless. Oil is fundamental in
> production and distribution and it is now an immediate concern.
>
> I don't think this planet can support so many without limitless
> resources. I'm getting older but I think my son will see a very
> different world than we have gotten use to.
>

Yes, very true.

> Best, Dan.
>
> Oh yea, do see that paper I posted for James.
>

> <http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcre...>

OK, I read this, and here are my thoughts:

Steve Keen is tacking some "Keynesian" thoughts onto a "Monetarist"
theory, and nothing he says is that controversial it seems, since "we
are all Keynesians now", meaning most economists have done the same
thing.

Keen's point, and I think yours, is that the monetarists are wrong
because there is no inflation until such time that the fiat money gets
converted to credit, and this credit is expanded. Thus we live in a
credit money world system, not a fiat money world system. This is
tautologically correct, and makes sense. My thought experiment to
support this: suppose the Fed announces that they have expanded the
money supply by 10 fold, and hence forth they will lend to anybody at
zero interest rate. They cannot go below zero (that is, pay people to
borrow money), since this is not conventional (but more on this
later). Hence, if no bank wants to borrow this money (because of
global fear of borrowing or leveraging, etc), then it means that these
banks don't want to lend, so in fact the money in circulation will not
change, so the "10 fold" expansion means nothing (the money just sits
in the Fed vaults, unused). The Fed's annoucement is of no
consequence. Only if government borrows this money and starts
spending it will the money in circulation change, as we have said.
But if government does nothing, nothing will change due to this Fed
announcement. This is very reasonable and plausible. But...

But here's another thought experiment to do, that might give Steve
Keen's theory a hiccup: suppose the Fed announces they will pay
people interest to take their money. That is, the Fed will lend money
at negative interest rates. Unprecedented, but this is inflationary,
and fiat money becomes synonymous with credit money.

Another thought experiment, more likely: suppose government borrows
money from the Fed with a maturity term of infinity. This was
actually done by the British government years ago--it's called a
"perpetual bond". The government will never pay back the principal,
it is 'rolled over' indefinitely, and interest is paid until
perpetuity. The government thus 'borrows' for N = infinity. Suppose
the US government thus borrows 25% of the GNP this way (that in fact
is Obama's present budget for FY2010). Is this inflationary?
Probably not, because the US economy is robust enough to pay off these
perpetual bonds forever. Suppose now we test this to the limit, and
the government borrows 1000% of GDP (10x). Is this inflationary?
Probably. Or 10000% or 100000% (1000x). At the limit, at some point,
the market will conclude the government will never be able to even pay
off the interest on these bonds, even if they tax all of the citizens
in the country at the maximum possible rate. At this point, when the
market realizes this, the market for these bonds will collapse, and
either hyperinflation or sovereign default will occur. Hence "fiat
money = debit money" for this scenario, at the limit.

Is this last hypothetical remotely possible today? Yes. Because
though the US government does not issue perpetual bonds, it does issue
10 yr and 30 yr bonds that have to be rolled over or refinanced. And
if it issues enough of these bonds, or rather, too many of these
bonds, the market will conclude the government cannot service this
debt load, and the market will collapse and/or hyperinflation will
(must) occur to pay off the debts.

Right now we're not remotely close to this 'limit', but in 20 years,
when Social Security must be paid, we might be.

RL

Excerpts I found of interest from Steve Keen's website here:

It also shows the importance of the nominal money stock, something
that neoclassical economists completely ignore. To quote Milton
Friedman on this point:

“It is a commonplace of monetary theory that nothing is so unimportant
as the quantity of money expressed in terms of the nominal monetary
unit—dollars, or pounds, or pesos… Let the number of dollars in
existence be multiplied by 100; that, too, will have no other
essential effect, provided that all other nominal magnitudes (prices
of goods and services, and quantities of other assets and liabilities
that are expressed in nominal terms) are also multiplied by 100.” [15]

The madness in Friedman’s argument is the assumption that increasing
the money supply by a factor of 100 will also cause “all other nominal
magnitudes” including commodity prices and debts to be multiplied by
the same factor.

Whatever might be the impact on prices of increasing the money supply
by a factor of 100, the nominal value of debt would remain constant:
debt contracts don’t give banks the right to increase your outstanding
level of debt just because prices have changed. Movements in the
nominal prices of goods and services aren’t perfectly mirrored by
changes in the level of nominal debts, and this is why nominal
magnitudes can’t be ignored.


With a sensible model of how money is endogenously created by the
financial system, it is possible to concur that a decline in money
contributed to the severity of the Great Depression, but not to blame
that on the Federal Reserve not properly exercising its effectively
impotent powers of fiat money creation. Instead, the decline was due
to the normal operations of a credit money system during a financial
crisis that its own reckless lending has caused—the Cavaliers are
cowards who rush into a battle they are winning, and retreat at haste
in defeat.

However, with his belief in Friedman’s analysis, Bernanke did blame
his 1930 predecessors for causing the Great Depression. In his paean
to Milton Friedman on the occasion of his 90th birthday, Bernanke made
the following remark:

“Let me end my talk by abusing slightly my status as an official
representative of the Federal Reserve. I would like to say to Milton
and Anna: Regarding the Great Depression. You’re right, we did it.
We’re very sorry. But thanks to you, we won’t do it again.” [18]

In fact, thanks to Milton Friedman and neoclassical economics in
general, the Fed ignored the run up of debt that has caused this
crisis, and every rescue engineered by the Fed simply increased the
height of the precipice from which the eventual fall into Depression
would occur.

Having failed to understand the mechanism of money creation in a
credit money world, and failed to understand how that mechanism goes
into reverse during a financial crisis, neoclassical economics may end
up doing what by accident what Marx failed to achieve by deliberate
action, and bring capitalism to its knees.

Neoclassical economics—and especially that derived from Milton
Friedman’s pen—is mad, bad, and dangerous to know.

RayLopez99

unread,
May 12, 2009, 1:53:41 PM5/12/09
to
On May 10, 3:47 pm, RayLopez99 <raylope...@gmail.com> wrote:

> Having failed to understand the mechanism of money creation in a
> credit money world, and failed to understand how that mechanism goes
> into reverse during a financial crisis, neoclassical economics may end
> up doing what by accident what Marx failed to achieve by deliberate
> action, and bring capitalism to its knees.
>
> Neoclassical economics—and especially that derived from Milton
> Friedman’s pen—is mad, bad, and dangerous to know.

Here's another person who failed to understand how money is created--
columnist and sometime venture capitalist Andy Kessler.

Note his classic fallacy that money created will be money spent
("Bernanke's printing press"), which may or may not happen. So far
apparently it has not happened much, though I feel this money will be
lent eventually by banks.

RL

http://online.wsj.com/article/SB124208415028908497.html

Was It a Sucker's Rally?
By ANDY KESSLER

The Dow Jones Industrial Average has bounced an astounding 30% from
its March 9 low of 6547. Is this the dawn of a new era? Are we off to
the races again?

I'm not so sure. Only a fool predicts the stock market, so here I go.
This sure smells to me like a sucker's rally. That's because there
aren't sustainable, fundamental reasons for the market's continued
rise. Here are three explanations for the short-term upswing:

- Armageddon is off the table. It has been clear for some time that
the funds available from the federal government's Troubled Asset
Relief Program (TARP) were not going to be enough to shore up bank
balance sheets laced with toxic assets.

- Zero yields. The Federal Reserve, by driving short-term rates to
almost zero, has messed up asset allocation formulas. Money always
seeks its highest risk-adjusted return. Thus in normal markets if bond
yields rise they become more attractive than risky stocks, so money
shifts. And vice versa. Well, have you looked at your bank statement
lately?

- Bernanke's printing press. On March 18, the Federal Reserve
announced it would purchase up to $300 billion of long-term bonds as
well as $750 billion of mortgage-backed securities. Of all the Fed's
moves, this "quantitative easing" gets money into the economy the
fastest -- basically by cranking the handle of the printing press and
flooding the market with dollars (in reality, with additional bank
credit). Since these dollars are not going into home building, coal-
fired electric plants or auto factories, they end up in the stock
market.

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