Gravy,
While I think that Rothbard really overlooks time in the quoted section of AGD, the quote nontheless perfectly states that basic Austrian relationship. His work on it in MES, particularly in the money chapter, goes over it in even more depth. What you and I are arguing here is by no means an obscure Austrian relationship, which is why I don’t understand why it seems so unknown around here.
Student,
My humble article proves Horwits mangled Say’s Law. I quote Say directly. https://smilingdavesblog.wordpress.com/2012/12/12/j-b-say-rises-from-the-grave-to-refute-steve-horwitz/
Mises writes in HA that money serves as a store of value.
Mises doesn’t mention it, because historically it never happened. There’s something called “a bank” that people use instead of “mattresses” for storing money.
But if you think you have shown that you understand AE with this last post, I won’t argue with you. I’m not here to change your opinion of yourself.
1932 quote: He doesn’t say it is undesirable either. Proves nothing.
1933 quote: Not sure what you want with this one. He says it’s bad short run, good long run. So what?
1978: This proves my point, actually. Key word here is “temorarily”, meaning bad and/or useless in the long run. Shows he is not in love with printing money. It’s a temporary fix. The problem is that it destroys the economy long run.
More evidence that you need to brush up on your AE.
My humble article proves Horwits mangled Say’s Law. I quote Say directly.
That’s great. So you quote one passage from Say and interpret Say’s Law one way. Horowitz quotes a different passage from Say and other authors and interprets Say’s Law differently. So where does that get us? “Smiling Dave understands Say’s Law differently than Steve Horowitz”. I’m pretty sure I already knew that. 
Am I going to have a detailed discussion with you about who is right? Where we dive together into original source material and see who comes out the victor? No.
I am not going to pretend I am an economic intellectual historian. Not even on the internet.
Mises writes in HA that money serves as a store of value.
That’s great too, I guess? But irrelevant.
My point is that he was ignoring this possibility in an essay where it is very important to recognize that people can hold money for reasons other than as a medium exchange.
By ignoring the fact that people can hoard cash Mises is able to “debunk” general gluts and demand-driven recessions by basically assuming them away. If your point is that Mises knew better, then I can only take that to mean he was using crude arguments to score political points in “Lord Keynes and Says Law”. :-/
Mises doesn’t mention it, because historically it never happened. There’s something called “a bank” that people use instead of “mattresses” for storing money.
So your explaination for why Mises doesn’t mention that people can hoard cash is because people never actually hoard cash, they deposit their money in banks (and have done so for all of time)??? If only someone had told Keynes there was such a thing as a bank! Intellectual history would be changed! Never mind that not all money deposited in banks is treated equally or loaned out to investors. For example, banks typically do not loan out most of the money people deposit in checking accounts and other demand deposits. This is why people have historically had to pay checking account fees instead of earning interest (you don’t earn interest on money just sitting in a vault). It is also why checking account deposits are included in most definitions of money (M1 and above).
But never mind that! Keynes just never heard of Banks. And Mises just happens to forget to explain that people will never hoard cash because…uh…Why? I guess he forgot because it was so critical to his argument. That makes sense to me!
So Mises was either a bastard that used crude arguments to win political points (even when he knew better). OR he was just really bad at explaining himself.
If this is you defending Mises, I would hate to see you attacking him.
First, apologies to everyone if I respond a bit slowly. You are raising deep questions, which need time to answer.
In the modern world, businesses usually need to borrow money if they want to expand. If money that used to be lent to them is now hoarded, then someone who used to get money is no longer going to get it, because the money he used to get is now hoarded.
Put another way, when the supply of available money for loans is cut in half, say, then, by the laws of supply and demand, the price of it will go up. The price of money is the interest rate. So if people hoard that portion of their money that used to be put into investment, the interest rate will go up, which will cut off some businesses from getting it. Not only that, the really long range projects that are usually only started when interest rates are low will now not get off the ground.
Second, it is not clear that the interest rate will go up at all. Mises expands in Human Action on what is the cause of the interest rate being what it is. He claims that supply of, and demand for, loanable funds, do not determine the interest rate. On the contrary, he says, and I quote, emphasis mine:
Originary interest is not a price determined on the market by the interplay of the demand for and the supply of capital or capital goods. Its height does not depend on the extent of this demand and supply. It is rather the rate of originary interest that determines both the demand for and the supply of capital and capital goods. It determines how much of the available supply of goods is to be devoted to consumption in the immediate future and how much to provision for remoter periods of the future.
People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.
The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.
Perhaps in a future article I will explain his argument in detail, meaning on what basis he makes these assertions. For now, You’ll have to read Chapter 19 of Human Action.
Bottom line, the interest rate is determined by the degree of time preference people have at the moment. If people hoard, what does that tell you? That their preference is directed, if anything, more towards the future than ever [otherwise they would spend now, not hoard], aka interest rates will sink, not rise.
Rothbard is saying something similar. The rate of interest, he says, is determined by rate of preference of present goods over future goods. The act of hoarding per se, he is assuming, doesn’t tell us that this preference rate has changed. [I argued that if anything it shows increased preference for the future. He is saying that you can’t really assume that, because hoarding and investing in a business both direct money towards the future]. Since hoarding per se does not tell us the preference has changed, why assume it did? Thus there is no basis for saying the interest rate will rise just because of hoarding.
I think Jargon’s objections are answered by the above, as well.
A note to Student: Applying the concept of time preference to money, an idea so basic to Mises’s writings, implies that money is a store of value.
One may ask, "But what about the fact that, after everything, there is less money to lend? Doesn’t this mean that some people just won’t get the money they used to?
Answer: What counts isn’t money per se, but the purchasing power of money. That will adjust so that less money is needed to buy stuff, ensuring an adequate supply of money in the banks to lend to everyone they used to.
Answer: The laws of supply and demand apply to money, but not to loans of money. When a person really really wants an Ipod, he is willing to give up on something else in order to afford it. But a business does not work that way. He has nothing to give up. There is a fixed rate of profit he can have [and Mises explains why this rate is related to time preference and originary interest], which determines how much interest he can pay on a loan. If, for example, his profit is 5%, he will obviously never borrow money at 6%. So although the banker might try to raise the rates, the borrowers will have no choice but to refuse. The banker, in turn, will have no choice but to lend at the old rate.
Student.
Horwitz has no quotes from Say that support his position. Put thy cards on the table. Show me the quotes.
I already explained why he did not bother with Keynes’ notion of mass hoarding.
- (and have done so for all of time)
Who is talking about for all of time? Keynes is trying to explain recessions, which existed only after there where central banks, which in turn have existed since some time in the 1600’s.
- If only someone had told Keynes there was such a thing as a bank!
Oh, he knew there were banks. He didn’t understand them, or thought he could fool you, which he apparently did.
BTW, if you claim there is hoarding, prove it. Enough of your wild, unsupported claims. Samuelson, [of all people!] has done the research proving there was no hoarding during the Great Depression. I mention it in this article which you will no doubt enjoy: https://smilingdavesblog.wordpress.com/2013/01/23/summary-of-keynes-theory-and-the-flaws-in-it-that-any-layman-can-spot-a-mile-away/
But I think your question is a deeper one. Keynes is God, you are saying. He never makes any mistakes, never lies. The high priests in your university have assured you this is true. I get it.
- Never mind that not all money deposited in banks is treated equally or loaned out to investors. For example, banks typically do not loan out most of the money people deposit in checking accounts and other demand deposits. This is why people have historically had to pay checking account fees instead of earning interest (you don’t earn interest on money just sitting in a vault). It is also why checking account deposits are included in most definitions of money (M1 and above).
I guess you never heard of fractional reserve banking. For every dollar someone puts in a bank, the bank has ten dollars to lend. So if someone puts a dollar in a bank and the bank just keeps it there, the money supply has not been reduced by one, but increased by nine.
- And Mises just happens to forget to explain that people will never hoard cash because they will deposit their money in the banks. Why? I guess he forgot because it was so critical to his argument.
I’ll explain so that everyone can understand. Let’s assume for the moment that if the moon is made of green cheese, that Mises is somehow refuted. So you are asking me why Mises did not even bother mentioning that the moon is not made of green cheese [in a short article that surveys the topic]. After all, you seem to be arguing, it is incumbent upon him to refute every possible argument, even those based upon assumptions that exist in Bizzaro World, but not on Earth.
I admit, I don’t know what to reply to such a thing.
BTW, it’s not my argument that people put money in banks, but Hazlitt’s. Just mentioning it for those who don’t give much weight to my arguments, but do respect Hazlitt’s. I don’t mean you, Student.
Horwitz has no quotes from Say that support his position. Put thy cards on the table. Show me the quotes.
WTF?
Dude. The quote is in the article I linked. The article is a scanned image so it is not easy to copy and paste, but even if it was easy I would not go get the quote for you. Two reasons. First, I think it speaks volumes that you have not actually read the link I posted but criticize Horowitz anyways. Second, like I already said, I am not interested in parsing the words of a dead French economist. If you want to write another lengthy blog post explaining why you feel like Horowitz misquoted Say or needed to read him in a wider context, feel free. But don’t expect me to weigh in.
Besides. The one thing I do know about economic intellectual history is that it is not easy when it is done right. It requires not only pulling choice quotes, but spending a lot of time with original sources, understanding not only the historical context, but sometimes even the particulars of translation. It is history as much as it is economics. This might be why Horowitz does not only build his case on the basis of a single quote, but also by citing other scholars that have written more exentisevly on the topic. That being said. If you think you actually have a legit beef with Horowitz based on the extensive time you’ve spent with the source material, take it up with him. He is pretty responsive to e-mail I hear.
Oh, he knew there were banks. He didn’t understand them, or thought he could fool you, which he apparently did. Samuelson has done the research proving there was no hoarding during the Great Depression.
But I think your question is a deeper one. Keynes is God, you are saying. He never makes any mistakes, never lies. The high priests in your university have assured you this is true. I get it.
WTF?
Dude. My point is not that Keynes is never wrong. My point is that if you honestly think Keynesians had never heard of fractional reserve banking, and that their arguments are so vulernable to such simple attacks, then you are the one being fooled.
I guess you never heard of fractional reserve banking. For every dollar someone puts in a bank, the bank has ten dollars to lend. So if someone puts a dollar in a bank and the bank just keeps it there, the money supply has not been reduced by one, but increased by nine.
WTF?
Dude. Re-read that paragraph. I understand what fractional reserve banking is. But you need to understand that not all deposits in the bank are treated equally. The fraction of reserves held in the bank for demand deposits (like checking accounts) is much much higher than the fraction of reserves held in the bank for savings accounts or CDs and the like. This is why checking account deposits are defined as part of the money supply. It is also why you typically PAY banks for the privledge of having a checking account instead of them paying you money for the privledge to loan out the “savings” you store in that account.
I’ll explain so that everyone can understand. Let’s assume for the moment that if the moon is made of green cheese, that Mises is somehow refuted. So you are asking me why Mises did not even bother mentioning that the moon is not made of green cheese [in a short article that surveys the topic]. After all, you seem to be arguing, it is incumbent upon him to refute every possible argument, even those based upon assumptions that exist in Bizzaro World, but not on Earth.
WTF?
Dude. If everyone agreed that hoarding cash was impossible, then you might have a point that failing to mention cash hoarding would be like not mentioning the moon was made of green cheese. But the fact of the matter is that the potential for people to hoard cash is the CRUX of what he was talking about. Failing to mention the most crucial piece of your argument seems pretty strange.
Dave,
I really don’t understand what you think the chain of causality is here, and this just goes to (in my mind) advance the idea that Mises’ words obscure rather than illuminate.
First of all you shoot yourself in the foot with your specific example. Prices go down by approximately .0526% (1.052695=99.997). The interest rate rises to 5%. His costs are now $95. At interest this is $99.75, NOT 98.8 (951.05=99.75). In terms of the original price level his costs have now gone up to $105 (99.75*1.0526=104.99685). If he is working on the margin he will not be able to continue production at his increased costs. I don’t understand why you thought the results would be different. Prices have adjusted downwards proportionally, but the interest rate has risen. Therefore real costs will be higher. If your example is supposed to be a major point then you have proven my point.
What you continually seem to avoid is the consumption vs. investment ratio, present goods vs. future goods. Other than this factor your summation of my point is perfect, but if you ignore this then it’s all moot. Remember, consumption drives production towards current goods while investment shifts it to future goods. It is a constant tug-of-war between these two factors. If money is taken out of investment and hoarded then the price level will fall, but the real value of money on the consumption end increases.
In the quoted sections by Mises he seems to basically be saying that originary interest determines what occurs on the loan-market, not the other way around.
I think your interpretation of Rothbard is exactly the opposite of what he is saying, or your comments here are absolutely irrelevant to what we are talking about, because Rothbard comes a hairs breadth away from what I’ve been saying this entire time. This whole discussion has not been about hoarding per se. We agree that hoarding per se will, in the long run, merely decrease the price level and everything will be as it was, but instead we are talking about hoarding that comes out of INVESTMENT SPECIFICALLY. Hoards that come out of either investment or consumption specifically or more so than the alternative, will change the ratio and will change the rate of interest. This is exactly what Rothbard says:
Increased hoarding can either come from funds formerly consumed, from funds formerly invested, or from a mixture of both that leaves the old consumption–investment proportion unchanged. Unless time preferences change, the last alternative will be the one adopted. Thus, the rate of interest depends solely on time preference, and not at all on “liquidity preference.” In fact, if the increased hoards come mainly out of consumption, an increased demand for money will cause interest rates to fall—because time preferences have fallen.
Rothbard is saying that if plain savings occurs primarily from consumption then interest rates fall, time preference falls, and capital accumulation increases. This necessarily implies the inverse: that if hoards come primarily out of investment then interest rates will rise. This is the exact opposite of the second underlined part of the passage. Hoarding that comes out of investment signals a decreased time preference because individuals no longer care as much about future goods.
If you still disagree in your next response then please include the investment-consumption ratio in your analysis.
Edit
But seriously dude, check your math next time.
Neo,
You argue that this causes interest rates to rise, and that Rothbard agrees with you. Thus, in the one case where hoarding comes out of investments and not savings, interest rates will rise.
But that is confusing the cart with the horse. Interest rates rise for one reason only, a shift in time preference. A shift in time preference is something that happens inside a person’s head. When a person hoards, or does any other action, that does not magically affect what his emotions are. On the contrary, his emotions cause his actions. It his change in time preference, if there is any, that makes him hoard, not vice versa. And once he has changed his time preference, whether he hoards or not, interest rates will rise. Thus, an act of hoarding cannot be responsible for higher interest rates. All this is laid out in Chapter 19 of HA.
So I don’t see how it is possible to say “Hoards that come out of either investment or consumption specifically or more so than the alternative, will change the ratio and will change the rate of interest.” Hoards can only change the rate of interest if they change a person’s internal state of mind, and his internal state of mind will then change interest rates. But as I said, it works the other way round. His state of mind determines his actions, including how much and from which part of his previous budget he will hoard, and at the same time, how much the interest rate will be.
A careful reading of that paragraph from Rothbard that Graveyten quoted will show that he is making the same argument I made here.
Summary:
Rate of interest is determined by a certain time preference, an internal state.
Once the internal state changes to be more future oriented, interest rates will rise, whether hoarding exists or not.
Hoarding, without a change in time preference, will not change interest rates.
Thus, a change in time preference is neccesary and sufficient to change interest rates.
Also, hoarding is neither neccesary nor sufficient.
I think it speaks volumes that you have not actually read the link you yourself posted but criticize me anyways.
I know you are not interested in finding out what Say actualy wrote, despite being presented it on a silver platter. Which is fine. You do not have to know everything.
However, if, as you admit, you don’t know what you are talking about, it behooves you not to express an opinion. It’s called “intellectual honesty” and “integrity” and “basic humility”.
You certainly have every right to say “I read that Horwitz thinks such and such, and as a matter of religious faith I believe everything he writes without examination and despite others proving he is wrong, because I never bother to read what they write.” Because in that case you are telling us something about your personal belief system, not presuming to assert anything about the real world. And it may be of psychological interest to some.
BTW, what Say wrote is not important because he was French or not French, or because he was alive or dead when he wrote it. It’s important because blindness to Say’s Law is the very cornerstone of Keynes’s failure, as economists of all schools have agreed [although the Keynesians praise him for it. Their take is that although Say’s Law refutes Keynes’ from the get go, Say’s Law is wrong. This was because they did not bother to read Say and Mill and see that all Keyne’s’s silly objections to Say’s Law were anticipated and refuted by them. Exactly the blunder you are making.].
In any case, it is besides the point. I’m not sure if you are familiar with intellectual discussion, so forgive me if I state the obvious to make sure we are on the same page:
The truth or falsity of an idea or a fact does not depend on who said it. One does not successfully attack nor defend an idea by talking about the excellence of it’s originator [= Such a smart guy. Never misses the obvious. So many people agree with him. The ceiling cannot support us. Has heard of fractional reserve banking. Considers himself an Austrian.] nor by belittling him [Dead. French.]. That’s why I never bring up Keynes’s many distressing personal deficiencies in these discussions.
An idea is to be judged on its own merits. Does reality contradict it, or not? Is there a logical flaw in it, or not? Is it correctly deducible from first principles, or not? Thus, when you see something that contradicts Keynes, the way to go is not to tell us how smart he was, but to address the idea itself.
Dude. You err in thinking that banks do not lend out money in demand deposits. You probably think that since it’s a demand deposit, and the customer may withdraw his money at any moment, the banker would not dare lend it away, or ten times it. In other words, you don’t know what fractional reserve banking is.
Dude. CRUX of what who was talking about? Not Mises in that article. As I pointed out earlier, he said that the money shortage thing was handled by Adam Smith, and he is going to talk about Say.
I think that after seeing the way our back and forth is going, we disagree too much on the very basics to have a fruitful discussion. Good luck to you in pursuing these fascinating topics.
Well, nobody’s perfect, not even Smiling Dave.
I found Chapter 20, Section 7, of HA discusses the effects of deflation on the [gross market] interest rate. Some of what he wrote shows me wrong in some of I wrote. Everything he wrote there applies to the [non existent in reality] case of hoarding as well, and takes care of Neo’s objections.
Turns out that what I wrote was correct about originary interest, but not about the gross market rate of interest. Neo nailed it about the gross market rate. So Neo, you have won the battle.
But don’t think you have won the war. Mises, though he grants that the gross market rate will rise temporarily, yet he explains why no real damage will happen as a result. As he puts it, no protracted scars are left.
Some highlights. [Fun quiz: I made up one of the quotes in italics. Can you spot which one it is?]
…a cash-induced rise in the gross market rate of interest produces a temporary stagnation of business. Deflation and credit contraction no less than inflation and credit expansion are elements disarranging the smooth course of economic activities, and sources of disturbance.
However, it is a blunder to look upon deflation and contraction as if they were simply counterparts of inflation and expansion.
Deflation and contraction are less likely to spread havoc than inflation and expansion not merely because they are only rarely resorted to. They are less disastrous also on account of their inherent effects.
C’mon guys, read the section.
5. Bottom line:
No protracted scars are left…
Deflation and credit restriction never played a noticeable role in economic history.
One thing still bothers me. Rothbard’s argument only applies to the originary rate, no? Why did he ignore the gross market rate? Is it because medium to long term, it too is not influenced by hoarding, for the same reason as with originary interest? Was he only trying to refute Keynes assertion that permanent unemployment is in the cards for wealthy countries?
Would appreciate any enlightenment.
I think that after seeing the way our back and forth is going, we disagree too much on the very basics to have a fruitful discussion. Good luck to you in pursuing these fascinating topics.
Yah, that sums it up.
EDIT: Oops, didn’t see your most recent post Dave. I’ll hang my neck out though.
Dave I’m just going to quote these sections because I think the central issue is here.
If societal time preference goes down, meaning people start to discount the future against the present less severely than before, then the structure of production will be lengthened, as people will withdraw their money from consumption (lower order goods) and towards savings. The ratio after this of savings vs. investment is not determined, but a time of economic stability will be a greater inducement to devote savings towards investment. But it does follow that a ratio exists, as long as there is any opportunity for investment available anywhere. Can we agree that this is the case? It follows then, that any lowering of societal time preference does indeed increase the supply of loanable funds, though the degree to which it does varies greatly.
The originary rate of interest, then, determines the supply of loanable funds. The demand for capital, then, determines the demand for loanable funds.
If people hoard, it tells us precisely nothing about their time preference insofar as we don’t know how much they have retracted from investment., as time preference is essentially a measure of abstention. Societal time preference may have changed not at all but funds have been transferred from investment to hoarding. If people start to hoard and more of that hoarding comes from consumption than from investment, the cost of capital is reduced more than the interest rate (as much as the interest rate is reduced by the reduction of supply of loanable funds, ignoring the rise which may follow given new cheapness of capital). If people start to hoard and more of that hoarding comes from investment than from consumption, the supply of loanable of funds is reduced and capital remains relatively devoted towards the lower stages of production. The relative scarcity of capital which follows this then means a reduction in capital accumulation.
You point to the increased purchasing power of money as some sort of counterbalance to a new capital scarcity which hoarding from investment would induce, but who are the beneficiaries of this increase in purchasing power? Consumers store the cash under their mattress and retailers, in an attempt to get them to buy, will lower their price. So this increase of purchase power augments the consumer because it is the consumer who is usually the source of capital and who has just retracted it.
Even if this were not so, let’s take an experiment:
On an island, there are 9 people. A cobbler and his apprentices, a fisherman and his, and a shepherd and hers. Each of them abstains from consuming a portion of their daily produce of the work of the lower orders of production, so that on sundays they can build and repair tools. This is akin to banking in a capitalist system. They have a system of money. One day the fisherman decides not to use sundays to build tools and he also abstains from buying any of the materials he usually buys on sundays to do so. Yes his handful of coins will gain in value as an abstention from buying things in general will lower the price level. But the stock of capital goods is not at all increased from this increase in purchasing power. Nor has capital in general increased, as goods are now simply nominated differently by money.
If purchasing power is a source of capital accumulation, then why was 1930 not the greatest year for capital accumulation, seeing as the value of gold soared? By your logic the increase in purchasing power should have trumped the sucking of resources out of investment and into hoarding.
Deep stuff, Jargon.
Just to make sure we have the context clear, the following is a discussion of the influence of hoarding on the originary interest rate. See Human Action Chapter 19 at length for the requisite background info.
If people hoard, it tells us precisely nothing about their time preference insofar as we don’t know how much they have retracted from investment., as time preference is essentially a measure of abstention.
Isn’t hoarding, by definition, abstention? Especially the kind of hoarding Keynes is talking about, long term hoarding. If the hoarding was of money used to invest, then maybe time preference is not lengthened [=more future oriented], but I don’t think it has been obviously shortened. If it comes from money used to consume, then that is definately an indication that their time preference is more future oriented.
…but who are the beneficiaries of this increase in purchasing power? Consumers store the cash under their mattress and retailers, in an attempt to get them to buy, will lower their price. So this increase of purchase power augments the consumer because it is the consumer who is usually the source of capital and who has just retracted it.
Everyone will benefit, because commodity prices go down as well, benefiting the producers who use them.
On an island, there are 9 people…But the stock of capital goods is not at all increased from this increase in purchasing power. Nor has capital in general increased, as goods are now simply nominated differently by money.
It has increased for everyone else but the fisherman, in the sense that what he used to buy and he now abstains from buying becomes available for everyone else.
If purchasing power is a source of capital accumulation, then why was 1930 not the greatest year for capital accumulation, seeing as the value of gold soared?
Increased purchasing power is a result of increased production, or of increased abstention, which is effectively the same as increased production for the non abstainers. In other words, it’s not a source of capital accumulation, but a symptom of it happening.
The value of gold may have soared, but the value of the dollar didn’t. Besides, 1930 was suffering from a decades long orgy of malinvestment, starting with the incredible destruction of capital of WW1, so how could it possibly be a time of record capital accumulation? The malinvestments had to be washed away first.
By your logic the increase in purchasing power should have trumped the sucking of resources out of investment and into hoarding.
Who says there was any hoarding? See earlier posts that it never happened.
A final question. Why is all this being addressed to me? Am I not merely repeating what Mises wrote in Human Action, Chapter 18, Section 9?
Dave,
As happy as any red-blooded person is to hear these words “you have won the battle”, I think that what you think I was right about is indeed, as you suggest, only a short run detail and it wasn’t the thrust of my point. In what I believe you are talking about Mises was talking about the effects of a decreasing the money supply and how this runs something of the reverse of effect of ABCT.
At any rate, I’ve finally gone through the trouble of digging up a quote from Rothbard where he explicitly reiterates what I’ve been saying this entire time. I’m particularly disturbed that you posted a mathematical example that was supposed to prove your point, and yet when I showed it proved the opposite you moved straight past it, nor did you deal with the investment-consumption ratio which is essential to understanding capital theory even when I directly asked you to. Therefore I feel like I have just been reiterating myself, and that you have not in any way provided a real critique this whole time; nor am I even convinced that you fully understand the theory you advocate. For these reasons I’m not going to spend much more time on this, so here are three simple reasons that demonstrate what I have been saying in simple terms or terms that directly deal with the way you’ve been phrasing things:
“Hoards can only change the rate of interest if they change a person’s internal state of mind, and his internal state of mind will then change interest rates.”
This isn’t a coherent line of thought. Someone has to change their preferences (time or otherwise) before they make a change in the way their money is allocated, hoarding is no different from this. How could hoarding cause someone’s mind to change when this change in preferences must have necessarily occurred first? I understand that you are arguing against this point of view, but nonetheless it should have been obvious from the get go that you were erecting a strawman. You also seem to have a somewhat mystical view of the interest rate here in that you are not looking about how it is determined by market interactions (which you can argue ultimately come down to time preference quite effectively), but it’s not as simple as:
“His state of mind determines his actions, including how much and from which part of his previous budget he will hoard, and at the same time, how much the interest rate will be.”
His time preference (and other things) determines how much he hoards which in turn determines the interest rate. Hoarding is an expression of time preference (if we define the term broadly which is my only beef in a way) because it signals that this individual doesn’t desire future goods greatly enough relative to future goods to continue playing a part in the market, he would rather hold on to his money. Through the interplay of market interactions this then leads to an increase in the interest rate as there is more spent on consumption relative to investment than was previously the case.
Now let’s say tomorrow all investors become total hoarders and there’s only a single dollar, $1 left in investment. How could that single dollar being loaned out fund the economy? Bullshit, it couldn’t. Net deflation would be 50%, prices would fall by half, but the amount being invested would fall by the full brunt of the spending decrease. The interest rate would skyrocket to thousands of percentage points and that single dollar would be holding of consumption for one more day, all other processes would have to be extremely short, obliterating capital accumulation.
If hoarding from investment doesn’t affect the interest rate then this example would have to be false. Any other hoards that come from investment just see the above happen on a much smaller scale.
“Admitting, then, that time preference determines the proportions of consumption and investment and that the demand for
money determines the proportion of income hoarded, does the
demand for money play a role in determining the interest rate?
The Keynesians assert that there is a relation between the rate of
interest and a “speculative” demand for cash. Should the schedule of the latter rise, the former rises also. But this is not necessarily true. A greater proportion of funds hoarded can be drawn
from three alternative sources: (a) from funds that formerly went
into consumption, (b) from funds that went into investment, and
(c) from a mixture of both that leaves the old consumption investment proportion unchanged. Condition (a) will bring
about a fall in the rate of interest; condition (b) a rise in the rate
of interest, and condition (c) will leave the rate of interest
unchanged. Thus hoarding may reflect either a rise, a fall, or no
change in the rate of interest, depending on whether time preferences have concomitantly risen, fallen, or remained the same.”
-Murray Rothbard: Man, Economy, and State page 789
Edit
I’m pretty done in this conversation if this doesn’t convince you, but I thought this was an interesting way to look at things. This is addressed to you too Jargon.
Consumption is choosing to consume goods today rather than goods tommorrow. Investment is choosing goods tommorrow over today. As you suggest, if one takes money formerly used in consumption and saves it, this is abstention in consuming today, an extension in time preference. If one is investing and saves it then one is abstaining from consuming tommorrow.
If we use Mises’ “consumer democracy” hypothesis here then investment is literally a vote for tommorrow. By saving one removes one vote altogether, he is no longer casting his vote in the consumer’s democracy, but this does mean less support for whatever he was previously voting for. Therefore the side he was originally voting against won’t recieve as much support as they would have if he had switched sites, but they will recieve more real support than they otherwise would have.
Neo,
I indeed made a mistake in my numerical calculation. I pressed a 4 instead of a 5, or something. In any case, I didn’t continue looking for new numbers to mess with, because I saw Mises dealing with the whole question in Chapter 20 section 7. What he says basically is that a deflation, though it will affect everything eventually, need not affect everything at the same time. In some instances it will affect commodity prices more forcefully [at first] than the lonable funds rate, in other cases the opposite. If we accept that assumption, then it seems clear to me that the numbers can vary in every possible way, so there is no point in making up cases.
To your other points:
Note that I said that hoarding “may be” a symptom, or result of a shift in time preference. Sometimes it is and sometimes it isn’t. Rothbard seems to be saying that they way to tell is to look at the ratio of consumption to investment before and after the hoard. I am not sure whether he is right, to be honest. Why is the hoarded money suddenly removed from the equation? In my [provisional] opinion, the hoarded money should show up in the equation, given a weight that would depend if it was taken from consumption, or from long term investment or from short term investment. [More on this in 6. below].
I take issue with the second half of that statement. It will determine the gross market rate, yes. But we have agreed to put that aside for now. It will influence the interest rate because it will result in a shift of prices of commodities, which means by definition almost a shift of who has how much money. What I mean is, if the hoarder used to buy feathers and now stops, the price of feathers will drop. The owners of feathers will be poorer. The poorer a man is, the less influence he has over the rate of originary interest, because his time preference is not as influential in the markets as that of a rich person.
But other than that, hoarding doesn’t influence the originary interest rate at all. The originary interest rate is tracable ultimately to time preference, a mental phenomenon. And the mental phenomenon exerts its influence on the interest rate without having to resort to intermediaries such as hoarding. You say that hoarding signals his time preference. But no signals are needed. All the person has to do is act according to his time preference and his influence is exerted on the interest rate. If he is a businessman, and the originary interest rate in his head is 5%, he will not expand his business unless it will get him a profit of 5% in his estimation. If he has money, he won’t lend it to anyone unless he gets his 5%.
In particular, you write that “it signals that this individual doesn’t desire future goods greatly enough relative to future goods to continue playing a part in the market, he would rather hold on to his money.” There is obviously some typo there. Not sure how to correct it.
You attribute to me the following: “…hoards from investment leave the ratio constant and leave the interest rate stagnant or are somehow offset by price decreases through net deflation.” Yes to the first part. I retract the second part, as above.
In the extreme case you mentioned, remember that we are not talking about short term effects. Initially the reduction of the money available for lending to a single dollar may definately influence the interest rate. But the interest rate will not rise to thousands of percentage points after things have queited down. It’s impossible, for the simple reason that the profits from running a business, say selling frisbees, do not rise to thousands of percentage points just because there is only only dollar available to be borrowed. If he makes 5% profit on a frisbee, he still makes only 5%, not a thousand percent. Thus he will only borrow at less than 5%, because he will go broke if he borrows at a higher rate.
Not only that, if thousands of percentage points are out there for the taking, there will be a rush of money into the loan business to take advantage of that great opportunity, until, as Mises says, it will start tending to the profit rates of all businesses, which, in a free market, all tend to the same rate of profit.
No capital would be obliterated, either. Who would obliterate his capital just for a dollar?
What would happen is people would go back to barter to get their loans. If our frisbee maker needs to borrow money to buy red dye, he will approach the dye maker directly, find out what he wants a year from now, say cabbages, and offer him 4% more than the going barter price for cabbages, i.e. pay him 4% interest. Yes, it will all be very clumsy and inconvenient. But nobody will obliterate their capital.
Also, he clearly says in the last sentence that changing time preference is what causes the change in interest rates, and the hoarding only reflects [not causes and not determines] the change in interest rates.
Now to be honest, that quote from Rothbard seems to support you, not me, as I mentioned above. And if that’s what he means, then I disagree with him. Hopefully someone will find an answer.
Dave,
Thank you for your in-depth reply. Nonetheless I still don’t believe you have displayed a clear knowledge of capital accumulation in the market economy. So for this reason I’m going to keep this post as brief as possible and I may or may not decide to post any replies to anything you post in return.
If time preferences changed dramatically but for whatever reason no one’s actions changed then interest and capital accumulation wouldn’t suddenly change. Time preference doesn’t directly affect interest and capital accumulation, rather it does so through the market. It is only because their actions are reflected on the market that this is at all the case, and hoarding is one case of this because it will cause interest rates to rise regardless of the motivation for removing the hoards.
“It’s impossible, for the simple reason that the profits from running a business, say selling frisbees, do not rise to thousands of percentage points just because there is only only dollar available to be borrowed. If he makes 5% profit on a frisbee, he still makes only 5%, not a thousand percent.”
Loanable funds shifts dramatically to the left, dramatically increasing the interest rate. The interest rate rises dramatically. Stages farthest away from production fail en masse and production is now almost entirely presently oriented. This means that the profit margins for some goods or some quantities of goods rise dramatically because the supplies of many goods shift leftward or stop existing altogether. Profits are not the same. You are right that it probably wouldn’t rise that high, however, since even then there are limits.
“Not only that, if thousands of percentage points are out there for the taking, there will be a rush of money into the loan business to take advantage of that great opportunity, until, as Mises says, it will start tending to the profit rates of all businesses, which, in a free market, all tend to the same rate of profit.”
This would occur with any dramatic increase in the interest rate. If I assume no one has any real time preference except for the investors it wouldn’t. What really scares me is the bolded section. That’s not how it goes. Profit reflects the interest rate. The interest rate doesn’t reflect profit. The reason why even in the ERE there is accounting profit is because this is how much firms must be provided in monetary compensation to induce any investment. As the interest rate increases the “normal rate” (although most Austrians would swat me for using the word) of profit increases. The interest rate is, in the long run, unaffected by profit margins. Profit margins are affected by the interest rate, however.
An increase in the interest rate increases general profits, but shortens the production structure and the supply of final stage goods. The opposite occurs with a fall in the interest rate. There’s a reason why the Austrian theory of interest is known as the “pure time preference” theory
“No capital would be obliterated, either. Who would obliterate his capital just for a dollar?”
The capital stock is ultimately obliterated through massive capital consumption because of the increase in the interest rate. People aren’t comsuming capital because of a dollar, but because of the absence of 500 Billion dollars that makes long run operations unprofitable.
“What would happen is people would go back to barter to get their loans. If our frisbee maker needs to borrow money to buy red dye, he will approach the dye maker directly, find out what he wants a year from now, say cabbages, and offer him 4% more than the going barter price for cabbages, i.e. pay him 4% interest. Yes, it will all be very clumsy and inconvenient. But nobody will obliterate their capital.”
Barter would obliterate capital. Rothbard says as much in MES. Advanced production structures cannot exist under barter because providing for the coincidence of wants of the workers would be more or less unmanageable. The amount of overhead and administrative oversight needed to ensure this would certainly decrease the real profitability of long-run firms in the first place to near oblivion. Modern society could not function off of barter, and with the loss of that there’s a massive loss in capital accumulation.
I hate to ask this but have you read Man, Economy, and State? I’ve seen you cite it before but you’re not representing a knowledge off of what Rothbard spends the longest time discussing: capital accumulation and interest rate determination. You instead seem to be focusing on Mises, and as I keep saying Mises never provides a step-by-step analysis of events. He outlines the real results of what happens, but he does not show clearly why. Hayek made the Austrian framework really workable and Rothbard clarified the work of both infinitely.
Deep stuff, Neo.
If you are going with Rothbard, what are you going to do with the Rothbard quote in your previous post that states hoarding “reflects” [meaning “does not influence”], interest rates?
I don’t understand what you wrote here. “You seem to think that time preference just magically determines the interest rate. It doesn’t. The only way that this is reflected on the market is through the interest rate and the factors that determine it.” What is the noun that the word 'this" stands for? I know you didn’t mean what I’m about to say, but the sentences seem to be saying that time preference determines the interest rate through the interest rate.
I am not going with magic here, and I don’t think we disagree by much in principle. A person has a certain time preference in his head. Faced with any economic decision he has to make, he asks himself “Is doing this going to suit my time preference?” In particular, he will only accept an interest rate that suits his time preference. As markets tend to do, they will bend to his will depending on the power he has. The resultant of all the bendings made to everyone is what the market looks like.
I agree with most of your second paragraph. Of course sitting in ones armchair and meditating on ones time preference will not determine anything. Certainly it is through his actions [and important inactions] in the market that the market changes. What I do disagree with is your seeming assertion that hoarding changes the interest rate if nobody’s time preference has changed.
My position is that if people have changed their preferences, their actions will eventually change the rate. If they haven’t, it won’t, because they will not take actions in the first place that will cause the rate to change, since such actions are not compatible with their time preference.
Where does hoarding fit in in all this? Simple. It is just like any other market action. It’s nothing special, and has no magical power to change interest rates [beyond temporary stuff etc as we agreed on earlier] if time preferences have not changed. That’s because the hoarding, like everything else a person does, will be done in a manner consistent with his time preference.
And if time preferences have changed, everything a person does will reflect the change, and everything he does will put pressure on interest rates to conform to his new preference. And if hoarding is one of those things that influence the rates to change in a manner that reflect his preference [which I doubt, but will accept for the sake of argument for now], why is hoarding such a villian? Why declare that is causes recessions and destroys capital? The new rate is exactly what people want. Blame it on them, not on hoarding.
Whatever change happens in the market in such a case is ultimately because people have changed their preference. And I don’t think anyone has ever claimed that a change in time preference per se is what caused the Great Depression. Or maybe they have. Who knows what outlandish things they are concocting out there? But the reality is that people change their minds about things all the time, and no harm done.
Why pick on poor hoarding? Why not declare riding the bus to work as the cause of recessions? After all, the decision whether to ride the bus, or walk, or drive, or take a cab, reflects his time preference. Why didn’t Keynes decide that we should outlaw buses?
Perhaps I should have said that if loanable funds dropped to a single dollar, people would find an alternate currency. Maybe gold, maybe whiskey, maybe euros, whatever, it doesn’t matter. Something will turn up. But they will not pay a thousand percent interest, and profits will not rise to a thousand percent because there was only a dollar of loanable funds. They will only pay a rate consistent with the originary rate, which is determined soley by time preference.
I think that’s begging the question. We agreed that would happen for a short time. We are discussing whether it will bounce back or not. So how can you just assume it won’t to prove it won’t?
“The interest rate rises dramatically. Stages farthest away from production fail en masse and production is now almost entirely presently oriented. This means that the profit margins for some goods or some quantities of goods rise dramatically because the supplies of many goods shift leftward or stop existing altogether. Profits are not the same.”
All true in the short run. But new people will then enter into that part of the market, reducing the profit rates to roughly what they used to be. As long as time preference is the same, the originary rate stays the same, and it determines what profits people will settle for. And because it’s a feee market, a higher profit rate than the originary rate will draw people into that market until the profit is lowered to be compatible with the originary rate of interest. Thus there is both a lower bound and an upper bound for profits in any industry, and they tend to converge to the same number.
The interest rate, too, will settle down to conform to the originary rate [as it must, because time preferences have not changed], and so the opportunities for profit in longer stage methods of production will return.
I think that’s turning a cart into a horse. The correct version is that there is one horse, time preference. How does one state precisely what the time preference is? After all, we won’t get very far just saying things like “People really really prefer the future lately.” One way is to say “They would give up one dollar today only if they get $1.05 a year from now”. From this way of describing time preference, we can abstact a number, 5/100. We call that number the rate of originary interest. It is not a measure of profits, nor of what banks are charging to lend money. It is a measure of one thing only; what is going on in people’s heads.
As we said, time preference, something in people’s heads, is the horse, meaning the cause of everything else. It pulls two carts, meaning it affects two things. It affects what profit will be acceptable to people, and what interest rate will be acceptable to people. Both those rates are manifestations of what is going on in people’s heads. Not by magic, but because people act based on what is in their heads.
So that profit margins and interest rates, meaning what banks charge one for borrowing money, are twin sisters, both the daughter of the rate of originary interest, a number which exists in people’s heads. But neither is the parent of the other. Profit margins do not beget interest rates, nor vice versa.
BTW, how can you say that the interest rate is unaffected by profit margins? If I know I can make 50% on some sudden opportunity, I will borrow at 40%. But if the best I can do is 5%, I will never borrow at 40%. [This does not contradict the above analysis of the mother and her two daughters, because this is a one-off exceptional case, called entrepreneurial profit, as Mises explains. It cannot last, and will revert right back to to conform to the originary rate eventually].
But the increase in the interest rate happens because of a change in time preference. It is this change in time preference that is also the cause of the increase in general profits [beyond the short term], because the change in time preference that caused the rise in interest rates also causes people to not settle [in their heads] for less than a new, higher, rate of profit. If they can’t get it, they won’t invest.
If people are still willing to settle for a lower profit margin, that’s exactly what will happen, due to competitiors entering the field who will settle for that lower rate. The rise in interest rates cannot force up profits if that rise in profits is incompatible with time preferences.
And that’s why the Austrian theory is called the pure time preference theory, BTW. Because time preference, absent sudden surprise temporary opportunities clever people discover, is what makes the whole thing run.
Long run operations turning unprofitable does not induce capital consumption. It induces diversion [= changing to a new use] of capital from one use to another, from long range to short range production schemes. Diversion and consumption are not the same thing, although the diversion may of course mean some of the capital becomes useless until long range production becomes profutable again. But even that does not mean its “consumed”. Nobody consumes it.
BTW, even if an economy only has very short range production schemes, it can accumulate capital. As Crusoe makes more and more fishing nets, he is accumulating capital.
As for MES, I have not read it cover to cover. I’ve heard he doesn’t contradict what Mises wrote, except for some details here and there. So I don’t think you are going to find something in Rothbard to refute what I write, which is basically just a summary of Mises [you’ll remember I’ve cited Chapter and Verse of HA]
After all that said, I do feel that need to hit the books for a while. You raise intricate subtle issues, Neo. So I too may have to take a break.
Dave,
Your response was a good one, nonetheless I’m pretty done with this discussion. I’ll answer any questions you have though.
“If you are going with Rothbard, what are you going to do with the Rothbard quote in your previous post that states hoarding “reflects” [meaning “does not influence”], interest rates?”
What are you talking about here? Rothbard said directly that hoarding may or may not influence interest rates. All that matters is where the hoards come from. This is explicitly what he said in my quote, and what was necessarily implied in the quote in gravy’s post.
“What is the noun that the word 'this” stands for? I know you didn’t mean what I’m about to say, but the sentences seem to be saying that time preference determines the interest rate through the interest rate."
I’m saying that the only way time preference is reflected in the market is through the interest rate which is in turn dependent upon the investment-consumption ratio.
“We are discussing whether it will bounce back or not. So how can you just assume it won’t to prove it won’t?”
You make a good point here I find it wholly unlikely that the interest rate will bounce back to it’s old rate, because for this to happen actors with funds numbering 250 billion would have to have the same time preference as the old investors.
“BTW, how can you say that the interest rate is unaffected by profit margins? If I know I can make 50% on some sudden opportunity, I will borrow at 40%. But if the best I can do is 5%, I will never borrow at 40%. [This does not contradict the above analysis of the mother and her two daughters, because this is a one-off exceptional case, called entrepreneurial profit, as Mises explains. It cannot last, and will revert right back to to conform to the originary rate eventually].”
I was talking about long-term effects, which is what I assumed was what we were discussing. Economic profit is a short-run phenomenon which eventually reverts to just accounting profit that equal to the rate of interest.
"Long run operations turning unprofitable does not induce capital consumption. It induces diversion [= changing to a new use] of capital from one use to another, from long range to short range production schemes. Diversion and consumption are not the same thing, although the diversion may of course mean some of the capital becomes useless until long range production becomes profutable again. But even that does not mean its “consumed”. Nobody consumes it.
BTW, even if an economy only has very short range production schemes, it can accumulate capital. As Crusoe makes more and more fishing nets, he is accumulating capital."
Time needs to be taken away from current projects to produce projects in the future. In order to produce his net Crusoe needs to take time away from fishing now. Even if the production structure isn’t lengthened in the sense of more production 5 years from now, there could still be a greater amount moved from 1 year in the future to 2 years in the future. In this respect the production structure is indeed “lengthened”
As the interest rate increases capital consumption necessarily occurs in a few ways:
Capital values decrease
Non-durable capital is not replaced
Durable capital is used up more swiftly than it would have otherwise been because of 1
This leads to a shorter production structure. When the new ERE is reached it will be less capital intensive than the previous state because the difference in the capital between the two will have been consumed.
“7. As for MES, I have not read it cover to cover. I’ve heard he doesn’t contradict what Mises wrote, except for some details here and there. So I don’t think you are going to find something in Rothbard to refute what I write, which is basically just a summary of Mises [you’ll remember I’ve cited Chapter and Verse of HA]”
To my knowledge Rothbard never directly contradicts Mises, yet as I have said several times I am not convinced you understand these essential Austrian concepts:
Capital theory and the structure of production
The investment-consumption ratio and how this determines the interest rate
You have consistently failed to address the second factor despite the fact that I have repeatedly asked you to, and these two aspects are almost wholly absent in HA. Mises gives the outline of the relationships (higher interest rate less capital intensive projects, lower time preference lower interest rate, more capital higher living standards), yet he doesn’t explain how one really gets there and the investment-consumption ratio, an essential clarifying element, is entirely absent from his work.
Please read MES, I think that it would make you a much better economist. If nothing else read chapters 5-8, because this is exactly where your misunderstanding seems to lie. Chapter 8 in particular would be extremely helpful here.