I had posted some questions, prompted by my thoughts on “the paradox of thrift”. I found that it seemed to be moving more toward a discussion than the question format, so I decided to open this related post.
I’m fairly new to Austrian economics (or any economics for that matter), but my understanding is that in a sound-money and free market economy, deflation would be the norm. My concern is that this would make lending completely impractical, as wages would constantly decrease and, for example, I may quickly find myself earning less than my monthly mortgage, making it impossible to pay the loan back. One thought I had was that borrowing and lending may not even be necessary in a sound-money environment (bank lending is really just a way for a third party to get a cut of everything), but then I’m not sure that any really big projects would ever get off the ground without such borrowing and lending. I’d be interested in hearing different views on the subject.
Here’s all I know about it, a quote from Rothbard’s What has Govt Done to Our Money?
II.
Money in a Free Society
10. Stabilize the Price Level?
Some theorists charge that a free monetary system would be unwise, because it
would not “stabilize the price level,” i.e., the price of the money-unit. Money, they
say, is supposed to be a fixed yardstick that never changes. Therefore, its value, or
purchasing power, should be stabilized. Since the price of money would admittedly
fluctuate on the free market, freedom must be overruled by government
management to insure stability. Stability would provide justice, for example, to
debtors and creditors, who will be sure of paying back dollars, or gold ounces, of the
same purchasing power as they lent out.
Yet, if creditors and debtors want to hedge against future changes in
purchasing power, they can do so easily on the free market. When they make their
contracts, they can agree that repayment will be made in a sum of money adjusted
by some agreed-upon index number of changes in the value of money. The
stabilizers have long advocated such measures, but strangely enough, the very
lenders and borrowers who are supposed to benefit most from stability, have rarely
availed themselves of the opportunity. Must the government then force certain
“benefits” on people who have already freely rejected them? Apparently,
businessmen would rather take their chances, in this world of irremediable
uncertainty, on their ability to anticipate the conditions of the market. After all, the
price of money is no different from any other free prices on the market. They can
change in response to changes in demand of individuals; why not the monetary
price?
Artificial stabilization would, in fact, seriously distort and hamper the workings
of the market. As we have indicated, people would be unavoidably frustrated in their
desires to alter their real proportion of cash balances; there would be no opportunity
to change cash balances in proportion to prices. Furthermore, improved standards of
living come to the public from the fruits of capital investment. Increased productivity
tends to lower prices (and costs) and thereby distribute the fruits of free
enterprise to all the public, raising the standard of living of all consumers. Forcible
propping up of the price level prevents this spread of higher living standards.
Money, in short, is not a “fixed yardstick.” It is a commodity serving as a
medium for exchanges. Flexibility in its value in response to consumer demands is
just as important and just as beneficial as any other free pricing on the market.
By sound money, I mean the volume of money cannot fluctuate at the whim of a central bank or government. The volume would be fixed (or at least strongly limited by a commodity, such as gold). These circumstances would cause the value of the money to fluctuate more in relation to goods. It would generally cause price deflation as productivity increases; the number of goods and services would increase, but the amount of money would not. I would assume that the same price deflation would also necessarily lead to lower wages, but I could be wrong there. We haven’t seen this situation in the modern world because no countries have sound money. They all inflate.
Rothbard’s concept is very interesting, but I’m still not sure of the practicality. It means that the payoff amount would keep changing and the payments could fluctuate from one month to the next. Here’s where my brain starts to hurt- Would there be an advantage for me to save up $25 now, borrow $50, and then payoff the whole amount with my saved $25 when the value of the payoff amount decreases? Would this pose a disadvantage to the lender? If this would not create any such moral hazards, then Rothbard’s solution would work. I’m just not mathematically inclined enough to wrap my head around it.
You misunderstand moral hazard completely. Whatever assumptions you have about the future value of X (including money) is competing with the assumptions about X of the party with whom you’re voluntarily trading X. That will be reflected in the price at which such trade will occur. This is valid for the price of stocks, bonds, cars, hot-dog stands, factories, and, finally, money.
I see your point. I agree that it would not be likely to create a moral hazard for the borrower, but could it create a disincentive to lend? If deflation would be the normal tendency and payment is based on some sort of complex formula of changing value, lenders would always tend to get back less money (perhaps not in actual buying power, but in the amount of dollars, sheckles, dinars, etc.) than they loaned out. If that’s the case, wouldn’t lenders be better off just putting the money under their mattresses? There would be no benefit in lending.
When a borrower becomes desperate enough, he’ll be willing to pay enough interest, or make some other concession, to make it worth the lender’s while. That’s what an interest rate is about, and why it should be settled between the two parties, not by some outside act of God.
So are you dismissing Rothbard’s idea and suggesting that in a deflationary world, borrowing would be limited to those who are extremely desperate (and, as such, would probably not be granted loans by anyone)? I imagine that there might also be a demand for borrowing among those who are extremely confident that their ability to profit from a loan will far outstrip deflation, allowing them to pay back an amount that may grow significantly in real value from the time that they first borrowed it. Either scenario makes borrowing and lending seem pretty harrowing.
I suppose what I’m questioning is whether any sort of long-term or large scale lending would be practical in the absence of a central body acting to moderate the fluctuating value of money. Knowing all the evils of the National Bank, I certainly don’t want to believe such a thing. I’ve heard several thought-provoking arguments, but nothing to completely resolve my doubts. Believe me, I want to be wrong on this.
Is long-term usage and large scale trading of computers “practical in the absence of a central body acting to moderate the fluctuating value of” computers?
One last thought. You make it sound like no money was never lent in the history of mankind until a central bank was set up to moderate the fluctuating value of money. People borrowed and lent money for millenia before there was any central bank, and things worked out just fine.
“It would generally cause price deflation as productivity increases; the number of goods and services would increase, but the amount of money would not. I would assume that the same price deflation would also necessarily lead to lower wages, but I could be wrong there.”
would the wage earner overtime likely become more productive commanding a higher wage..producing more better???
but computers have a use in terms of direct consumption. Money does not. For example, I would buy food no matter what, even though it becomes worthless after consumption. The personal value to me is in the consumption. I’m not arguing that deflation would prevent consumption, only that it may prevent borrowing and lending.
This is not a fail by the standards of the Central Bank. The purpose is constant devaluation of money. That’s what ensures that it is generally profitable to borrow and lend. When the Fed gets it right (which they obviously don’t always do), borrowers will tend to command higher wages over time and the price of investments will tend to increase.