A Critique of Mises's Praxeology (Part 1?)

[z1235]

@Fool on the Hill

If you want to do A (i.e. if A resides at the top of your value stack),

That is, if I want to do A now.

“other things being equal” (i.e. your value stack remains unchanged), you prefer to do A sooner rather than later.

That is, if I can’t do A now I will then want to do it at T+1, and if I can’t do it then, I’ll want to do it T+2, etc. This qualification makes the first proposition completely unnecessary. I can simply skip it and say that if I prefer to do something at T+1 and I can’t also do it at T+2, then I prefer it sooner rather than later.

I don’t know how to proceed except by repeating what I already wrote three times. It has happened before, so I’m not surprised.

You prefer to do whatever is at the top of your value stack to not doing it (i.e. to postponing it, because in an uncertain world, things don’t stay equal for too long).

That is, I prefer to do now what I prefer to do now.

Yes, you (can) only do now what you prefer to do now. You can not do now what you will prefer to do in the future, nor can you prefer now something which you will do in the future. Human action.

Are we then assuming that lenders prefer to spend all of their money now? If they didn’t prefer to spend their money now, then the borrower wouldn’t have to pay interest, since interest payments are merely incentives to prevent the lender from spending his money.

Interest/rent is payment to the owner of property/good/asset X for relinquishing (transferring) control over X. Consuming X is not the only way of excercising control over X.

This doesn’t seem to hold a priori. I prefer to save money for my retirement quite regardless of whether I earn interest on it. Yet, this doesn’t prevent me from earning interest on it. I can imagine a world where every lender prefers to save their money for retirement and yet refuses to lend it out without interest. I mean, what if the borrowers vastly outnumber the lenders? Wouldn’t the competition among the borrowers drive up the interest rate quite regardless of whether the lenders wanted to spend their money now?

Mises used time preference to explain the existence of interest. He never claimed that time preference (on its own, to the extent it could be quantified, and without regard for supply/demand) would quantify (calculate) it.

And does this explanation of interest as some sort of compensation hold true for other forms of “surplus value”? Do I pay rent because my landlord would prefer to sleep in my apartment if I didn’t pay him not to?

You pay rent because your landlord, in return, has agreed to relinquish control over his apartment for a period of time. You pay a larger amount (i.e. you buy the apartment), in return for him relinquishing control over it forever.

[z1235]

@Fool on the Hill

No recourse to the time preference of the lender then is needed to explain this interest rate. Spending the money now was never at the top of my stack. So the interest can’t be seen as compensation for the lender’s loss of spending.

I’ve described my own explanation for the existence of interest before (too lazy to dig it out) which I think can easily be connected with the time-preference explanation. I see it as compensation for the lender’s loss of control over what has been lent out. Given the choice between: (a) keep my $1,000 for a year, and (b) relinquish control over them for a year, i.e. lend it out, the price at which I would choose (b) must have something to do with my estimation of how what transpires in the world over said year would affect my value stack. If I estimated that over the next year there would be plenty of instances where the top of my value stack would involve my control over said $1,000, then I would be demanding more in return for relinquishing control over them for the year.

In fact, if the interest is supposed to serve as compensation, then it should be paid to Borrower A and not to the lender. After all, it is Borrower A who wants to spend the money now and would be spending the money now had she not been prevented from doing so by Borrower B.

So all rapists should be paid compensation whenever they were unable to do what they would rather be doing (raping)?

Mises’s theory breaks down once we assume that the demand of borrowers exceeds the supply of lenders. This of course is true of the real world. Despite what he says, when it comes to interest, Mises in fact assumes conditions of equilibrium.

You have been confused about the meaning of “demand” for a while now. The fact that $6 billion people would all prefer to fly in their own private jets does not mean that there is a disequilibrium of supply and demand in the aircraft market.

[Fool_on_the_Hill]

excel: But borrower A doesn’t possess the money now, and never did, and is therefore incapable of having ‘spend $1000’ at the top of her stack (At least, the $1000 that you might have lent her).

Well, I (the lender) never had anyone offer to sell me a product before lending the money, so how could I have “spend $1000” at the top of my stack? The point I thought Mises was making was that the lender would have spent the money if he hadn’t lent it, and that the interest was supposed to serve as equal compensation for whatever he was thereby deprived of. My point is that if Borrower B didn’t borrow the money, then Borrower A would have borrowed and spent it. If the interest is supposed to compensate the lender for whatever he was going to spend the money on if the borrower hadn’t come along and deprived him of it, then why wouldn’t there also be a mechanism to compensate Borrower A for whatever she was going to spend the money on until Borrower B came along and deprived her of it? (Note that I don’t accept the theory of interest as compensation. I’m using the example of borrowers being paid interest to illustrate this point.)

After all, A might have wanted to spend $10000 right now, whereas there might be 9 other pension-savers aside from you that preferred to keep their moolahs in the mattress. Is she now owed interest from the mattresses? What if those 9 other people lent the money to C through K? Would A through K then be owed the interest of each of those other loans that they might have wanted but were unable to secure?

You tell me. I don’t think the interest rate is determined by compensation.

You may prefer to save those $1000 for your retirement at the moment you made the loan, but that does not guarantee that those preferences will remain static during the duration of the loan, nor does it mean that A will have the ‘spend $1000’ preference as a constant for the duration of B’s loan either.

Sure. My understanding of Mises was that the estimated preference only matters at the point of the loan.

I don’t really see how Mises’ theory breaks down here. Does it assume that interest is to be paid purely due to time preference with no regard to contract?

My impression of Mises was that time preference determines the conditions of the contract.

At most I feel your example shows that in this case the interest is not only indicative of your personal preference (prefer to lend out $1000 at 5% interest rather than keeping it in the mattress or lending it out at lower rate) but also indicative of B’s preference ($1000 dollars now with the 5% rate etc.), however this would surely already be implicit from a praxeological standpoint?

Sure. People prefer to do what they do. That’s a tautology. The question is whether they do it for reasons of “time preference.”

At most I feel your example shows that in this case the interest is not only indicative of your personal preference (prefer to lend out $1000 at 5% interest rather than keeping it in the mattress or lending it out at lower rate) but also indicative of B’s preference ($1000 dollars now with the 5% rate etc.), however this would surely already be implicit from a praxeological standpoint?

Depends what you mean. The lowest I would be willing to lend the money out would be 0%. If I were offered any percent I wanted, I would choose infinity percent. The reason I lend it out at 5% is because that is the most that someone offers me. Given that the two numbers that are relevant to my preferences are 0 and infinity, it’s hard to conclude that my preferences have much of anything to do with the interest rate ending up at 5%. On the other hand, A’s preferences range from negative infinity to just under 5%, and B’s preferences range from negative infinity to at least 5%. So the preferences of the borrowers seem much more decisive in determining the interest rate.

[Fool_on_the_Hill]

z: I don’t know how to proceed except by repeating what I already wrote three times. It has happened before, so I’m not surprised.

I know how that feels.

You can not do now what you will prefer to do in the future, nor can you prefer now something which you will do in the future. Human action.

With the qualifier that doing something now excludes you from doing it in the future. I prefer to post on Mises right now, and I will also post on Mises in the future. Or I am breathing air right now, and I prefer to breath air in the future. Therefore, breathing air expresses no time preference.

Interest/rent is payment to the owner of property/good/asset X for relinquishing (transferring) control over X. Consuming X is not the only way of excercising control over X.

What is your definition of consuming?

Mises used time preference to explain the existence of interest. He never claimed that time preference (on its own, to the extent it could be quantified, and without regard for supply/demand) would quantify (calculate) it.

My impression was that he thought time preference determines the quantity of interest. Given this, we should be able to formulate general principles such as a lower time preference on the part of the lender leads to lower interest rates. To test this a priori knowledge we should be able to come up with a priori hypothetical examples where the time preferences of the individuals are arbitrarily given. If we can show that under certain circumstances, the reduction of the lender’s time preference does not affect the interest rate, then the law has been shown to be problematic and not apodeictic. I have given an illustration of where the lenders time preference does not determine the interest rate, therefore I believe I have proven the law to be merely problematic, or possible. Given that it is possible, we then have to consider whether it is assertoric–that is, whether the conditions of its necessity are actually the case. My judgment of the empirical evidence is that they are (generally) not.

I’ve described my own explanation for the existence of interest before (too lazy to dig it out) which I think can easily be connected with the time-preference explanation. I see it as compensation for the lender’s loss of control over what has been lent out. Given the choice between: (a) keep my $1,000 for a year, and (b) relinquish control over them for a year, i.e. lend it out, the price at which I would choose (b) must have something to do with my estimation of how what transpires in the world over said year would affect my value stack. If I estimated that over the next year there would be plenty of instances where the top of my value stack would involve my control over said $1,000, then I would be demanding more in return for relinquishing control over them for the year.

This actually sounds pretty close to what I said earlier: “Thus, the reason the interest rate is always positive is not that we always prefer to use something now as opposed to later, but because we prefer to have the ability to use something now or later to just the ability to use something later…What the interest rate really does is compensate me for my loss of social power—my power to control others through the regulation of the use of objects.” The amount of interest corresponds to the level of control and not to the level of the satisfaction that said control brings. I think it is important to note that control here does not refer to physical control but to legal control. By selling an object, one does not relinquish one’s physical ability to control the object.

So all rapists should be paid compensation whenever they were unable to do what they would rather be doing (raping)?

Even though I included an “if,” I should have known that my sentence would be misinterpreted. It should have read something like: “In fact, if the interest actually served as compensation for lost “satisfaction,” then one would expect to find the interest being paid to Borrower A and not to the lender.”

You have been confused about the meaning of “demand” for a while now. The fact that $6 billion people would all prefer to fly in their own private jets does not mean that there is a disequilibrium of supply and demand in the aircraft market.

I thought that my use of demand may not have been clear. I am not sure what terms to use as I want to communicate the importance of both the amount that borrowers are willing to borrow and also the relative number of borrowers. In my scenario, the lender was willing to lend $1000 at 0%. Two borrowers were each willing to borrow $1000 at 0%. Thus, the total supply is $1000 and the total demand is $2000. That is not an equilibrium.

The fact that there are two borrowers is important. If there was only one borrower who was willing to borrow $2000, then the interest rate could remain at 0% even though demand exceeded supply. Similarly, if there were two borrowers but each only wanted to borrow $500, then the interest rate could remain at 0% because total demand and supply were in equilibrium. The fact is, when demand exceeds supply and there are multiple borrowers competing with each other and are all willing to borrow at a rate above the lender’s minimum, then the interest rate is determined by the borrowers alone.

It is interesting to note that the borrowers could achieve lower rates through unionization. If they negotiated with the lender as a collective unit, then they could get the $1000 at 0% interest. A and B could then bid for the loan, the winner then paying the other borrower the resulting interest. I use this example as an illustration of how things could be different, not as something I advocate.

[excel]

If the interest is supposed to compensate the lender for whatever he was going to spend the money on if the borrower hadn’t come along and deprived him of it, then why wouldn’t there also be a mechanism to compensate Borrower A for whatever she was going to spend the money on until Borrower B came along and deprived her of it? (Note that I don’t accept the theory of interest as compensation. I’m using the example of borrowers being paid interest to illustrate this point.)

Because borrower A wasn’t deprived of anything in your example.

Sure. My understanding of Mises was that the estimated preference only matters at the point of the loan.

Does this exclude the possibility that a lender might estimate his possible preferences that might occur in the future as well?

My impression of Mises was that time preference determines the conditions of the contract.

But for the lending/preference contract to form there would in this case need to be exchanged the $1000 between lender and borrower. The contract does not spring into existence the moment someone sees a $1000 marguarita machine that just ‘to die for’ , but is only formed by the agreement between lender and borrower to form such a contract.

The question is whether they do it for reasons of “time preference.”

If it did not matter to B wether he spent the $1000 now or after he saved up $1000 of his own in 2 months and spent it then, would he have made the loan?

Depends what you mean. The lowest I would be willing to lend the money out would be 0%. If I were offered any percent I wanted, I would choose infinity percent. … On the other hand, A’s preferences range from negative infinity to just under 5%, and B’s preferences range from negative infinity to at least 5%. So the preferences of the borrowers seem much more decisive in determining the interest rate.

If your preference ranged from 7% to infinity, though, the loan would only have been made if either A or B adjusted their preferences or if some third borrower C could be found with a coinciding preference.

If we remove A from the equation, it seems to me that B would theoretically (if he had the knowledge of your preferences) be able to offer to lend at 0.1% interest. If you had said no, then your range of preference would not truly have been within 0% and infinity.

Even in an absurd situation where the lender has a strange drive to charge -6% interest and will lend at nothing else, whereas borrower B is unwilling to borrow at below 3% interest, the time preference of the lender is king, as the loan would not be made.
Even if B was willing to borrow at -5% or even -7%, but not -6%, the loan would not be made, as the preference of the lender would range from -6% to -6%.

So I would say that the preferences of the borrowers can only determine interest rates with the preference range of the lender.

[Fool_on_the_Hill]

Some additional “critiques” you might be interested in:

Notes on the Austrian Theory of Malinvestment

Must artificial credit expansion lead to overconsumption?