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Michael Fritsch of the Gold
Standard Institute has responded to my earlier post. While Fritsch raises a
number of points including seasonal variation in money demand, and the
inability of the price system to adapt to changes in supply, demand, and
consumer preferences, I am going to be selective in what I respond to because
for me there is one major issue that he and Fekete are grossly mistaken
about: in the Miltonic example that I cited, Fekete has
argued that there are not enough savings to support an increase in production
and that real bills can in essence substitute for actual savings. I am going
to limit my response to that issue because I don’t want to dilute my
response by delving into other areas.
Misunderstanding of Savings
The real bills advocates
consistently demonstrate a mis-understanding of actual savings. While money
is used to effect saving, we not save money and saving is not a monetary
process. The stream of final goods reaching the market is available for
savings. Saving is the consumption of some final goods to fund the production
of capital goods. In a monetary economy, we use money to save but to
understand saving is a real process. Out of the final goods reaching the
market some are “destructively consumed” and some are
“reproductively consumed”. The total supply of saving is the
latter category. In a monetary economy, these decisions are carried out using
money but it is only the stream of goods made available for
“reproductive consumption” that is available to fund investment.
James Mill has a
very good description of the real meaning of saving:
The two senses of the word consumption are not a
little remarkable. We say, that a manufacturer consumes the wine which is
laid up in his cellar, when he drinks it; we say too, that he has consumed
the cotton, or the wool in his warehouse, when his workmen have wrought it
up: he consumes part of his money in paying the wages of his footmen; he
consumes another part of it in paying the wages of the workmen in his
manufactory. It is very evident, however, that consumption, in the case of
the wine and the livery servants, means something very different from what it
means in the case of the wool or cotton, and the manufacturing servants. In
the first case, it is plain, that consumption means extinction, actual
annihilation of property; in the second case, it means more properly
renovation, and increase of property. The cotton or wool is consumed only
that it may appear in a more valuable form; the wages of the workmen only
that they may be repaid, with a profit, in the produce of their labor. In
this manner too, a land proprietor may consume a thousand quarters of corn a
year, in the maintenance of dogs, of horses for pleasure, and of livery
servants; or he may consume the same quantity of corn in the maintenance of
agricultural horses, and of agricultural servants. In this instance too, the
consumption of the corn, in the first case, is an absolute destruction of it.
In the second case, the consumption is a renovation and increase.
Fritsch states “Money
that could be used as savings under Real Bills would by necessity have to be
used to support the clearing function”. In the same passage Fritsch
states that:
Furthermore, all other things
being equal, if more of the total stock of money is available for investment,
aka savings, then interest rates experience downward pressure. If less cash
(relative to the total stock) is available, because it is used for clearing,
interest rates tend to rise.
The essential problem with
this view is to look at savings and investment in terms of the money stock.
This approach leads to the fallacy that conserving money is the same
economizing real resources. What limits production of final goods is the total
quantity of real resources available for investment. The total stream of
final goods reaching the market is divided into consumed goods and saved
goods. This division is carried out using money but it is not the money that
is saved, it is the final goods. Reducing the monetary cost of some activity
only makes more resources available for saving if the real cost is reduced.
The clearing process does not conserve any real resources, it only enables
the system as a whole to operate with lower money demand.
Interest rates are not, as
Fritsch says “driven by the ratio of savings to cash”, they are
driven by the consumption:saving ratio. This ratio can remain unchanged as
money demand moves up and down.
If the same set of
transactions can be carried out with less total cash flow, that does not mean
that they consume fewer real resources. To know whether or not a process
consumes fewer real resources, we need to know the prices and quantities of
the goods. For Fritch’s point to be valid, it would have to be the case
that when firms adopted clearing to reduce their money demand, that all the
same resources were available to them at the old low prices.
As an individual if I could
find a way to reduce the money costs of one activity then that would leave
funds available for other activities. However, to extend this reasoning to
the entire economy is a fallacy of composition. Changes in money demand due
to clearing do not make more real resources available for production because
there are offsetting price changes to a system reduction. The error in
analysis comes from a failure to take into account the seen and the unseen
effects. What Fritsch misses here is that there are offsetting adjustments to
the reduction in money demand elsewhere in the system – the prices of goods,
generally increase. Real costs of production for the clearing firms would
only be reduced if there were no offsetting effects in the price system to
the adoption of clearing.
While it is true that the
economy is not in an equilibrium, arbitrage opportunities to appear the price
system responds to them. In particular, the price changes initiated by the
introduction of clearing into a non-clearing economy would be arbitraged
away. If some sector of the economy or subset of firms began using clearing to
lower their money demand, even if initially the changes in prices appeared
initially in the goods that these firms traded, if they to continued to use
clearing, the resulting changes in relative prices between the clearing firms
and the non-clearing firms would open up arbitrage opportunities between the
clearing and the non-clearing part of the economy. There is no reason to
think that these price changes would permanent and not arbitraged away.
If some technological
innovation reduces the real
cost of production then real resources become available for
some other use. For example, suppose that a car could be produced with half
as much steel – then the steel would be available for some other use in
the economy. But reducing the monetary flow through a production process
— as clearing does — is not the same as reducing the real cost or
production. Reducing the money flow through a process does not make any real
resources available for another other use. The changes in money demand are
offset by changes in the price system and real costs are not changed.
Suppose that there are a
several production functions for a car, of the form X tons of steel, Y pounds of rubber, Z
hours of labor, use of K robots,…. There is always some
ability to substitute among different factors of production and to substitute
capital for labor or vice versa. The only way that the real cost of producing
a car could change with clearing is if there was a way to substitute a real
bill for X pounds of steel to produce a car made out of real bills.
I believe that there is an
unstated assumption in Fekete and Fritsch’s work that, when the
quantity of money or near-money is increased (through bills) that quantities
of goods somehow adjust upwards rather than prices adjusting upwards. If I am
right about this it raises a huge set of issues around how these goods can be
produced without additional real factors of production. He may be thinking
that the real bills themselves serve as a factor of production that can
substitute for real labor and capital. This is consistent with Fekete’s
statement that savings alone are not sufficient to fund production but that
real bills can.
Low Interest Rates
From Fritsch:
Low, steady interest rates
are clearly conducive to production; projects that would be sub marginal at
higher rates of interest become profitable if rates are low and steady. Real
Bills thus free Gold for longer term investment. Real Bills circulation is
essential to a workable Gold Standard.
“Low steady interest
rates are clearly conducive to production” as Fritsch says only if
those interest rates reflect the scarcity of actual saving. A monetary system
which achieves the objective of lowering interest rates to stimulate
investment through monetary means do not in reality make sub-marginal
production projects marginal because there is not sufficient real savings to
complete them; such projects only appear to be viable so for a time. I
won’t provide an explication here of the Austrian Business Cycle Theory
(ABCT) but there is plenty of literature on-line for those who wish to
investigate.
Robert Blumen
Robert Blumen is
an independent software developer based in San Francisco, California
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