This is a good point. I imagine that there probably was borrowing and lending in periods when a central body did not debase currency. I’d be interested in hearing from anyone who is acquainted with the history of such lending. Unfortunately, I think that governments have been inflating (even if it’s by clipping coins) throughout much of our recorded history. There may be fewer examples of a truly free market than we imagine.
Touche.
One word I don’t get here. “Lend.” How does inflation make it profitable to lend? You hand over A zimbabwe doallar that can buy a pound of onions and a year later get back a buck and a half that can buy one a single onion.
And if the lender ups the interest really high to cover for inflation, how is it profitable for the lender?
Why do you say they constantly would like to devalue money. Isn’t the reserve banks job to provide money to the economy?
There is as difference between their declared intention and what they really want to do.
BTW “provide money for the economy” is a very tricky phrase. Why do they have to provide money? What’s wrong with the money that’s already there? In fact, what’s wrong with me just up and making my own money if people are willing to use it? Like the fellow who made those Liberty Dollars until he was jailed?
truth is, such a phrase shows you need help. [Takes out prescription pad, scribbles on it].
Here ya go:
Think deeper. Whether a product X is consumed or used for something else has nothing to do with the more fundamental concept of trading X. Just look at lending as trading money and the interest as the price of the traded product (money). By lending you $100 for a year, I have merely sold you a product (the right to use my $100) for a price (interest). You’re arguing that no trading in product X can happen unless the price of X is controlled (“kept from fluctuating”!) by some central authority, which I hope you’d agree is quite absurd.
Finally, if you’re so bothered by what deflation would do to lenders, think as a lender and solutions will start popping out. How about I lend you my $100 for a year but I ask for the 5% interest upfront? If you’re so bothered by adjustable interest (a bond interest coupon tied to some measure Y, where Y could be inflation, deflation, or snowfall in Wyoming), check out TIPS (Treasury Inflation Protected Securities) – bonds whose annual interest coupon is tied to CPI and which have been freely traded in the market for decades already. Computers can do amazing amounts of math per second these days. [:)]
Voluntary exchange and free markets in EVERYTHING is preferable to control. Buyers and sellers in EVERY voluntary transaction are perfectly capable of defending their interests (pun intended), and are obviously made better off by the trade.
Z.
This goes back to my initial hypothesis that in an environment of constant deflation, nobody could ever pay back loans, because wages would always be decreasing.
According to the mainstream theory (one I don’t personally like, but I am, nonetheless, currently exploring for possible merit), constant inflation of about 4% per year helps to encourage consumption and investment by making saving unprofitable (it goes back to the whole “paradox of thrift” argument). This is supposed to keep the economy moving. I believe that Austrian theory has completely refuted the notion that inflation and a central bank are necessary to stimulate consumption. What I am now wrestling with is whether or not these things are necessary to promote lending and investment.
Rob,
The general of level prices will decrease, but not all prices will decrease equally. Since humans are usually net producers, labour will probably be relatively more scarce. And although the units of money you eventually pay back a debtor may be exchangable for more widgets than when you first borrowed them, those widgets are also relatively less coslty to produce, i.e. the actual burden of debt on you will probably not change (though it could for reasons unrelated to a fall in the general level of prices).
There’s your mistake. Why does lending and investment need to be promoted? If people aren’t interested in such things (i.e. they have a high time preference) then diverting funds from lower to higher-order goods will do nothing but harm for everyone.
Inflation is not necessary whether it promotes investment or not.
By the way, as for your “Computers have inherent use, money does not” comment, that’s also wrong; A natural money (that is, one selected by actors on the market rather than enforced by state fiat) can ONLY come into use if it is highly desired for its non-monetary uses. Otherwise, a more marketable good would be selected over it to engage in indirect exchange.
And “promoting” lending and investment beyond what the market itself is allowing is good because? You find the current sink-hole we’re in which was caused by excess lending and mal-investment desirable? “Promotion” of free lunches doesn’t actually make them free.
Z.
I understand how the Fed’s easy money creates the Boom/Bust cycle. I’m not dismissing Austrian theory outright. Until this current issue, it has provided me with solid answers to all of my economics questions. What I’m not sure about is if there would even be a market for lending and investment in the absence of steady inflation. Who would want to lend to borrowers that will most likely be unable to pay back due to constantly shrinking salaries? It’s possible that borrowing and lending are not necessary for a strong economy, but I suspect that we might not have any new skyscrapers, amusement parks, or department stores in the absence of credit. Is it feasible for large projects like this to be realized by simply saving up? I really don’t know. My only point of reference has been our current inflationary world with massive government intervention.
When I’m talking about “promoting investment,” I don’t mean it in the same way as a “Cash for Clunkers” program subsidizes people to buy stuff that they wouldn’t ordinarily want. I’m suggesting that inflation may create the very circumstances that allow for any long-term investment or lending to take place at all. In a deflationary society, the money would be spread increasingly thin as population and productivity grow (money will be spread among more people and more products). The value of money would increase, but the volume would not. This means that it would be possible (and perhaps likely) for the price of stocks to decrease on a company that is actually quite successful and increasing in real value. If I had bought stocks in that company ten years ago and try to sell them now, I would have less money than if I had simply buried the cash under a rock. There would be no incentive to invest!
Lenders today are not suckers to inflation. The expected inflationary rate is incorporated into the interest rate. Interest rates are higher due to inflation. The borrower pays an inflation premium. Inflation, in no way, helps the borrower.
In a deflationary environment, the rate of interest will be adjusted downward according to deflationary expectations. So interest rates will be lower due to deflation. Does this resolve your problem?
Milton Friedman and Anna Schwartz, using empirical data, casted doubts on this false assumption and actually helped to validate the Austrian firm stance on the manner:
[T]he price level fell to half its initial level in the course of less
than fifteen years and, at the same time, economic growth
proceeded at a rapid rate. . . . [T]heir coincidence casts serious
doubts on the validity of the now widely held view that secular
price deflation and rapid economic growth are incompatible.
(Milton Friedman and Anna J. Schwartz, A Monetary
History of the United States 1867–1960 [Princeton, N.J.: Princeton
University Press, 1971], p. 15, and also the important statistical
table on p. 30)
but wouldn’t money be more scarce than labor? The population will keep growing, so money will need to be spread more and more thin among the population. In the absence of someone printing more money, average salary cannot increase (or even stay the same) unless the number of wage earners decreases.
I understand that interest can be adjusted for deflation, but I’m more concerned about the fact that, as population increases and volume of money does not, wages will necessarily go down. This means that it would be much more likely for people’s salaries to drop to a point that they could not afford to pay back loans. Adjusting interest is one thing, but if you adjust the actual principle, based on deflation, lenders would be better off simply holding their money instead of lending it. There would be no benefit to receiving a lower amount of money back, regardless of any increases in “real value” of the money.
DD5- I may need to check out the Friedman book. Obviously, economies have existed, at various points in time, without the presence of a central bank. I definitely want to find more about the logistics of those economies.
Bear in mind that if we all expected radically falling prices, then negative interest rates could compensate. The lender would get repaid more in real terms, even though it might be less in monetary terms. Since the dollars the lender is getting repaid with are worth much more in the future (because of rising productivity), he might receive back the principle minus interest.
If the lender only gets back the same (or less) money than he or she loaned out (regardless of any increase in real value), wouldn’t it be better to just keep the money under the mattress and wait for deflation to kick in? What would be the motivation for lending?
Yes and no. It depends. There are costs and risks to stuffing money under a matress, so you might still lend the money.
By the way, a type of money that undergoing significant and sustained deflation ceases to function as a good medium of exchange. There is an implicit competition among all goods in an economy to function as money, and some are better suited to different conditions.