Couple of questions from Ron Paul's book (+1 from Hazlitt)

Economics Economics Questions
1

A few questions for the smart folks here at Mises:

These two questions are from Ron Paul’s End The Fed:

  1. Bernake says this in response to Paul’s claim that inflation is eroding the value of the dollar by increasing the money supply:

“If somebody has their wealth in dollars and they’re going to buy consumer goods in dollars-it’s a typical American-then the decline in the dollar, the only effect it has on their buying powers, it makes imported goods more expensive.”

Why is he saying it’s only imported goods? If the value of the dollar drops, prices go up (inflation). Prices will go up for imported and domestic goods.

  1. Bernake responds to another question with this: The only way to lower interest rates is to create more money. I have to lower the discount rate, I have to make it generous, I have to increase reserves, I have to lower the interest rates and fix the interest rates-overnight rates. And the only way you can do this is by increasing the money supply.

Is this basically saying I need more savings to lower interest rates? I envision a natural cycle of banks lending more when there is more capitol and if they have more capitol and want to lend more they can lower interest rates. So Bernake is saying that the Fed has to pump money into the system for us to see lower rates? I thought they could just set the discount rate that the banks borrow at and help with consumer rates.

This question is from Hazlitt in his book Economics in One Lesson:

His chapter on imports and exports surprised me. He says that debasing a currency to increase exports is basically pointless. He goes on to say that imports are paid with exports and that a business ships goods to a country and receives US dollars in return. He is then forced to buy something in the US with his dollars since he received credit in US Dollars. This forces him to spend the money in the US. He does say that trade deficits were occasionally settled with a shipment of gold but that isn’t really the case since we are not on the gold standard anymore. Why is he forced to spend money in the country he exported to? Why can’t he exchange his foreign money with any bank?

Thanks for the time spent reading and replying to these questions!

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  1. Yes. More dollars are competing for the same amount of goods → prices rise → people who get the money first gain at the expense of the people who get the new money later or not at all. This goes for all goods, foreign and domestic. Foreign currencies are also goods.

Bernanke doesn’t understand supply and demand, and thinks you can print with no negative consequences at all. He doesn’t understand that an economy is about the production of goods.

  1. Yes. More savings can lead to lower interest rates. More money can also lead to a lower interest rate (which is how the FED tries to set rates). More money without more savings in goods is economically destructive in many awful ways.

There’s also no need for lower interest rates (you cannot centrally plan the price for loaning money). Bernanke thinks people spending money helps the economy. Bernanke doesn’t understand the function of savings for increased production. He doesn’t understand saving now to consume more later. There is no later in Bernanke’s economic philosophy.

3

Hans Hoppe explains:

4

Haha, isn’t that one of the central tenets of Keynesianism? “The long run is a misleading guide to current affairs. In the long run we are all dead.”

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In regards to your answer to #1, I was surprised that Ron Paul goes on to immediately agree with Bernanke in the next paragraph but says it damages fixed income seniors. So is he trying to make a point that inflation doesn’t hurt you when buying imported goods because of cost of living adjustments employers give? Still confused as to why Paul agrees with the point..

#2: I understand that in a natural cycle saving more money allows banks to lend at a lower rate. What I think is driving this is supply and demand. The supply of money is higher so they can give it away for less money. But, maybe the point Bernanke is trying to make here is the argument for artificially lowering the interest rate (or discount rate in this case). I think he might be trying to say here that he has to increase the money supply in order to artificially lower the discount rate so the supply of money is increased commensurate with the interest rate reduction in order to keep up with demand. This of course leads to inflation and an artificial demand signal that is harmful. What type of harm? Well I just looked up a section in Hazlitt’s book (Economics in one lesson) and this is what he says:

“artificial reduction in interest rates encourage borrowing and highly speculative ventures that cannot continue except under artificial evolution. On the supply side artificial reduction of rates discourages normal thrift, saving, and investment. It reduces the accumulation of capital. It slows down increase in productivity…”

So my question now is why is artificially lowering the interest rate harmful? I realize this causes inflation and I’ll leave the harm of inflation for another topic. What I would like to understand is the quote Hazlitt published above. If I lower the rate I encourage borrowing.. Why is this so bad? Is it only bad if it is spent on highly speculative things? What is an example of highly speculative? I get that it discourages savings because who wants to keep their money in a savings account with a lower interest rate. I understand that it reduces capital because capital investment is essentially savings (which creates reserves for businesses to borrow from) and investments. So I guess it is only harmful (apart from inflation) if I borrow and spend speculatively…?

6

Austrian Business Cycle will answer your question

Economic Depressions: Their Cause and Cure

http://mises.org/daily/3127

How the Business Cycle Happens

http://mises.org/daily/1905

Austrian Business Cycle Theory: A Brief Explanation

http://mises.org/daily/672

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  1. About the Hazlitt q in the first post, to wit: Why is he forced to spend money in the country he exported to? Why can’t he exchange his foreign money with any bank?

He can exchange it in a bank, but what will the bank do with the money? Hazlitt is cutting to the chase, saying that the guy who finally spends the money can only do so in the USA, buying USA products.

  1. About the second Hazlitt q:

Is it only bad if it is spent on highly speculative things? The Austrian theory of the business cycle asserts that it is bad if spent on projects that cannot be completed. This happens when interest rates go up when the project is half finished, more money is needed to continue, but the high interest rate makes the money, and thus the project, too expensive.

Also, it is bad if the money is borrowed to make things people don’t want. It should be obvious why this is bad, a waste of resources. It asserts that this is very likely to happen when interest rates are low, for reasons too intricate for me to go into.

As you may notice, ultimately all the “bad” ways the money is spent come down to wasting resources on things people don’t want and/or cannot use.

What is an example of highly speculative? Speculative means buying something not because you think it has true value neccesarily, but because you can find a sucker to buy it from you at a higher price. Examples are all those dot.com stocks that had poor fundamentals, and houses that people bought to flip.

Hazlitt may also mean “high risk”, or “very unlikely to succeed”.

8

Let me try to interpret Bernanke’s arguments.

I believe he’s referring to the effects of inflation in the FOREX (foreign exchange) market. An inflating nation will put downward pressure on the objective purchasing power (exchange rate) of its own currency relative to other foreign currencies. As a result, international products will become more expensive. For example, suppose the USD/GBP exchange rate is at 1:1 in period (t1). Now suppose that, in period (t2), the U.S. doubles its supply of money and that currency speculators alter the exchange ratio so that 1 GBP buys 2 USD. British products, which previously cost $1, now cost $2.

Of course, this is only a single effect of inflation. As the nation expands its supply of money it will, at the same time, reduce market interest rates below their equilibrium position. Additionally, as the currency enters circulation, it will alter the structure of relative prices and may yield general price inflation. In the former case, you get the ABCT; in the latter situation, you get the destruction of savings, real wages, and a potential crisis in the bond market.

There are three ways to lower interest interest rates (I may be forgetting something): (1) a higher rate of saving, (2) a lower demand for investment, and (3) an expansion in the supply of money (which artificially resembles a higher savings rate). Ben Bernanke has to increase the supply of money (specifically, the supply of high-powered money) in order to lower interest rates (which will initially affect only short-term interest rates).

A foreigner could exchange the currency he receives in international trade for other national currencies. But the currency that leaves a nation, due to international trade, will inevitably come back into that nation, either to buy its products, and/or in the form of investment.

So for example, suppose that individual A, an American, buys a Japanese product from individual B. Individual A now has a Japanese product and individual B now has dollars. He can either (1) use those dollars to buy American goods, (2) invest in America, or (3) exchange those dollars to person C, a Brit, for Great British Pounds. In the latter scenario, situation 3, individual B will use his GBP to either buy British products and/or invest in Britain, while Individual C will use his dollars to either buy American products and/or invest in America. Of course, he could also exchange his dollars for another currency.