The most damning arguments against the modern fractional reserve bankers are your own arguments. You’re not the official spokesman for them, but honestly, their top scholars don’t provide much better responses either.
I think this misrepresents the free banking argument. Lawrence White and George Selgin do distinguish between a change in demand for bank-issued notes and a change in demand for base money. An increase in bank-issued notes over an increase in base money would be an increase in fiduciary media; an unrestricted increase in fiduciary media does cause a business cycle. One of the key parts of meeting an increase in demand for bank-notes is receiving gold in return.
The liabilities are NOT backed by gold. That would be a 100% reserve bank. The liabilities are backed by assets, which by definition, have a longer term maturity then that of its corresponding liabilities. Fractional reserve banks engage in maturity mismatching - borrowing short and lending long. This is considered to be unsound financial management by any financial standard that can think of. No business except FRB [systematically] engages in such financial practice except for Madoff type scams and of course, government debts.
To think that people would willingly exchange such liabilities as money (perfect liquidity) is mind-boggling. I’m sorry, but it is simply not to understand what money is.
You don’t say. You know what will happen in a free banking system? Where did you encounter one, because I will go buy the plane ticket today!
Jonathan, point taken. I was just trying out a new way of thinking about the issue.
DD5, nevermind.
Back on the matter raised by the original post. One should be careful to distinguish between a refutation of ATBC, and a refutation of a particular application of ATBC. For example, if Caplan could show empirically that, during a period of history, entrepreneurs anticipated higher interests and adjusted action accordingly, then any bust could not be explained by ATBC. That doesn’t mean that ATBC is not a very good description of some (or perhaps most) booms and busts, but merely that not all booms and busts must follow the ATBC story.
ATBC is a theoretical construct that describes how the world might be given particular conditions. If those conditions do not hold, then ATBC will not hold either. Arguing that the conditions do not hold in a particular instance is different to arguing that they can never hold at all. To properly critique ATBC it would be necessary to claim that such conditions (and the consequences that follow) are logically impossible or inconsistent with basic economic law.
Yes, but this could never happen. Interest rates are “high” when they are above the natural rate of interest, and “low” when they are below the natural rate of interest. Terms such as “high interest rates” or “low interest rates” are purely relative in nature; that is, a 4% market rate of interest may be too high, and a 15% market rate of interest may be too low. If individuals could just guess the “correct price” then markets don’t need to exist. We can just put those individuals who have some mystical connection to the market economy in power and they could set commodity prices, input prices, interest rates, ect.
Now, individuals may guess that a 2% interest rate is too low, but they don’t know where it should be (they don’t know the equilibrium position). If the equilibrium position (the natural rate) is at 30%, then they may think, and probably will think, that a 20% interest rate is “unreasonably” high. Rational expectations is absurd.
Huh?
Caplan is dismissing the ABCT because it predicts that entrepreneurs systematically make the same mistake over and over again. This is an affront to our commitment to the free market (conceived as entrepreneurial participants in an economy allocating resources according to the price mechanism, utilizing Hayekian knowledge).
Caplan is not assuming ABCT is true and then detailing counterintuitive consequences; he is saying even if it is true, it would already have been cured by the self-correcting mechanism of the market (much like investment strategies quickly become obsolete due to information dissemination among keen entrepreneurs).
To quote Caplan at length,
In short, the Austrians are assuming that entrepreneurs have strange irrational expectations. Rothbard states this fairly explicitly: “[E]ntrepreneurs are trained to estimate changes and avoid error. They can handle irregular fluctuations, and certainly they should be able to cope with the results of an inflow of gold, results which are roughly predictable. They could not forecast the results of a credit expansion, because the credit expansion tampered with all their moorings, distorted interest rates and calculations of capital.”[48] Elsewhere, he informs us that: “[S]uccessful entrepreneurs on the market will be precisely those, over the years, who are best equipped to make correct forecasts and use good judgment in analyzing market conditions. Under these conditions, it is absurd to suppose that the entire mass of entrepreneurs will make such errors, unless objective facts of the market are distorted over a considerable period of time. Such distortion will hobble the objective ‘signals’ of the market and mislead the great bulk of entrepreneurs.”[49]
Why does Rothbard think businessmen are so incompetent at forecasting government policy? He credits them with entrepreneurial foresight about all market-generated conditions, but curiously finds them unable to forecast government policy, or even to avoid falling prey to simple accounting illusions generated by inflation and deflation. Even if simple businessmen just use current market interest rates in a completely robotic way, why doesn’t arbitrage by the credit-market insiders make long-term interest rates a reasonable prediction of actual policies? The problem is supposed to be that businessmen just look at current interest rates, figure out the PDV of possible investments, and due to artificially low interest rates (which can’t persist forever) they wind up making malinvestments. But why couldn’t they just use the credit market’s long-term interest rates for forecasting profitability instead of stupidly looking at current short-term rates? Particularly in interventionist economies, it would seem that natural selection would weed out businesspeople with such a gigantic blind spot. Moreover, even if most businesspeople don’t understand that low interest rates are only temporary, the long-term interest rate will still be a good forecast so long as the professional interest rate speculators don’t make the same mistake.
Additionally, he states,
Thus, it is readily conceded that (a) expansionary monetary policy reduces interest rates, and (b) lower interest rates stimulate investment in more round-about projects. Where then does the disagreement emerge? What I deny is that the artificially stimulated investments have any tendency to become malinvestments. Supposedly, since the central bank’s inflation cannot continue indefinitely, it is eventually necessary to let interest rates rise back to the natural rate, which then reveals the underlying unprofitability of the artificially stimulated investments. The objection is simple: Given that interest rates are artificially and unsustainably low, why would any businessman make his profitability calculations based on the assumption that the low interest rates will prevail indefinitely? No, what would happen is that entrepreneurs would realize that interest rates are only temporarily low, and take this into account.
Here’s what it boils down to: entrepreneurs are notoriously specialized for forecasting market trends; obviously, this is imperfect, since ours is a system of profit and loss. However, why would errors be aggravated due to lower interest rates? Entrepreneurs are expected to consider consumer preferences, trade routes, hard-to-predict natural phenomena, and innumerable other factors that impact production–why, on Bob’s green earth, would lowered interest rates create outlandishly irrational beliefs that systemically create “malinvestments”? It destroys any intelligent nimbleness we attribute to entrepreneurs over bureaucrats.
Quoting gocrew, If the price of sweaters were suddenly to be lowered, even if I knew they had been artificially lowered, it doesn’t mean that I know how many sweaters there actually are and whether or not I should get in line (there will be a waiting line now) to get one. Am I one of the ones who would have purchased the sweater at the market price? Hard to know without knowing what the market price is/would be (I only know that it is higher than the current asking price).
Exactly why everyone is misunderstanding Caplan.
What if sweaters were lowered to a price where you decided to buy more? Is that a malinvesment? Why?
There is no sound reason that increased consumption, simply due to lowered costs, creates malinvestments. If you bought more sweaters, then I cannot challenge that preference; I bet that it maximized your utility.
there are many things that can be said against this, for now I will just go with this one…
consider a generic example of price fixing. not in the market for loanable funds, but in the market for steel say
lets suppose a department for controlling steel prices, draws up a schedule for the next year, of how it will push prices this way and then that way, and in case this happens with supply they do this, and if that happens with supply they will do that. and then they proceed.
would entrepreneurs be able to avoid ‘error’ by their skill at forecasting under such a regime?, or is it uncontreversial enough to admit that under political manipulations which intervene upon the market in a dynamic way, attempts of rationally allocating resources to meet the highest ends are thwarted. That such errors are in large part simply a function of the political will for errors to occur.
This response completely ignores the fact that there are market prices, and there are things that are not market prices, but politically established prices. they still determine what is to be exchanged in order to get the other thing (in theory at least). yet they completely eviscerate the market process annihilating it, incentivizing black market activity to plug the gap, since the legit market are wiped out.
cap the sales price of sweaters, and even though i might , in theory, buy double at this lower ‘price’ if only i could, there likely will soon not be sweaters to buy… eventually i will have to bribe people to get any sweaters of quality at all, severely impacting my income.
There is no sound reason that increased consumption, simply due to lowered costs, creates malinvestments. If you bought more sweaters, then I cannot challenge that preference; I bet that it maximized your utility.
There is if the costs are artificially lowered.
I think there is a difference between sweaters and money.
Sweaters can be used for something. You wear them. So if their price goes down, you got a bargain.
Money can’t be worn, or eaten, or used for anything but buying things. If the price of money goes down [=low interest rates] then you take it and start buying other things. Now if the interest rate was low because people were saving their money [which increases the amount of money in the banks, thus lowering interest rates], that means they were consuming less. After all, more savings means less consumption.
Which means resources are not going to be used so much to feed the consumers. They are not that hungry. So that the demand for resources is less, so that they are cheap. Meaning one can buy themn cheaply for building factories and other long range plans.
But if consumers are still spending, and the money in the banks is from newly printed money [the other possible reason for low interest rates, like nowadays], then resources are not more available in reality. What is more available is money. Meaning prices of resources will go up.
Now Mises originally wrote that business people will be fooled, and think there are more resources for long range projects than are really available. So they will start up new projects, and then find out that actually they can’t afford to complete them.
Caplan is not challenging any of this. He is asking something else, mainly, that don’t people know [eventually, after being fooled a few times] that interest rates are an unreliable guide? How do they get fooled over and over?
I remember reading Mises saying that, yes it is theoretically possible that eventually people will wise up.
Yes, in goods, you would expect a shortage if a price was artificially lowered (Mercedes-Benz vehicles being legislated at $1,000/car would cause a shortage, for instance).
But, clearly, you are not telling me that lowered interest rates create a shortage in credit, right? So, obviously, your example is idiotic.
Enterpreneurs compensating for interest rate interventionism is impossible, even if they knew the ABCT, due to the socialist calculation problem. Someone like Caplan would not resort to taking that into account because he also refuses to accept the socialist calculation theory. He has a whole pillar of mistakes stacked up.
my example is primarily meant to demonstrate that prices are meaningful and only perform their function for calculation when they are set by the market.
I don’t understand how the example of price fixing can be idiotic when its a perfect example of a problem that occurs with price fixing. I didnt claim it was perfectly analgous. the market for loanable funds is important for determining the structure of production . you will actually find that with investment having been diverted from lower stages to higher, and also resources plain malinvested, investments that would have been made in the counterfactual world without distorted interest rates havent occured in this world which had distorted interest rates and so at least as far as they are concerned, they have had a loss of investment. The boom and bust, is itself a deadweight loss wherein resources are squandered, this is another way of saying that things are yet more scarce than they would have been (production possibilites frontier has shrunk).
Was the example really so idiotic?
Caplan does not refuse to accept the economic calculation problem; he simply awaits empirical proof that it was the most crucial factor in the collapse of 20th-century centralized economies. He blames poor incentives.
Quoting Caplan, Ever since Mises, Austrians have overused the economic calculation argument. In the absence of detailed empirical evidence showing that this particular problem is the most important one, it is just another argument out of hundreds on the list of arguments against socialism. How do we know that the problem of work effort, or innovation, or the underground economy, or any number of other problems were not more important than the calculation problem?
No one has answered why bad investments would necessarily be made. Why, according to the Austrians, does “speculative” irrationality increase? Why don’t entrepreneurs have the same chance of profit-or-loss?
Yet he never seems to reach any conclusion that would require it…
work effort
without economic calculation one cannot allocate labour rationally (which includes allocating resources with which to incentivise and purchase the labour etc)
<<innovation
without economic calculation one cannot rationally allocate resources towards ‘innovating’ nor can one set about rationally utilizing possible gains from innovation.
underground economy
you mean the bit where the market fought back?
What do you think I just did? You are the same as Caplan. You just say that an answer is not an answer.
first of all, will you admit that prices (in general) are useful in guiding entrepeneurial decision making? and that conversely political price distortions interfere with that decision making, making it harder to do well, making the process yet more error-prone, speculative etc. ?