An increase or decrease in the amount of the commodity that serves as money, like the discovery of huge gold reserves.
The advent of an additional currency or commodity, like silver, that competes with the first currency.
A huge inflow or outflow of money from another country.
An increasing amount of IOUs that fulfill a simliar role as money (for example, a company buys its machines not with gold, but with company bonds, promising to pay at some later time).
A drastic increase or decrease in the velocity of money.
It would be terrific if you didn’t only answer with yes/no but also explain why/why not.
The basic idea, which I will slightly elaborate on a little bit later, is that business cycles are caused by one thing only: inflation. So the basic thing to look for is do these things cause inflation.
Also, it is important to remember that inflation doesn’t mean an increase in prices, but an increase in the amount of money flying around. [But only money that isnt desired for some other reason besides being money. This last Im not sure about, more on this later]
OK, on to the cases:
I think this actually happened in Spain after Clumbus discovered America. I think Wikipedia has stuff about it. The reasoning is that the ultimate cause of business cycles is inflation. Because more money seems to mean more factors of production are available as well, causing the boom, until it turns out, no there is no new stuff out there, causing the bust.
less money would not create a business cycle, because it just makes thing cheaper
If the second was forced down peoples throats by law, then it would be another kind of inflation [=increase in money supply] and so would cause business cycle.
But if it was voluntary, then I guess that means the new money has intrinsic value [meaning people would want it even if it wan’t money]. Why else would they accept it? And in that case the increase in the money supply means people are giving up a good when they use the new money, not grabbing up something for nothing. And they know it. So there is no false assumption that there has been an increase in raw materials. So no infaltion.
[I’m a bit shaky on that last paragraph, but it seems right to me].
Money from Country A, by the laws that exist nowadays, cannot be spent in Country B. It has to be used to buy money of Country B. If country B does not print new money, then there has been no increase in its money supply if Country A buys it, hence [by definition] no inflation, hence no business cycle.
An IOU just moves existing money from one person to another, it doesnt create new money. so no inflation etc. This is not the same as fractional reserve banking, where the banks in effect spend more money than they actually have, which is inflationary.
velocity of money has nothing to do with causing inflation. How does it? It’s not a printing press. It can be an EFFECT of inflation, that when people realize money is just gonna go downhill, they try to pass it on to the next guy as fast as possible. But its more a symptom than anything basic.
I don’t know about this. Price deflation due to increase in number of goods and services probably won’t, but deflation of the money supply suddenly contracting might.
We both agree that a sudden discovery of gold might cause a business cycle, so why not a sudden loss of gold? If the gold reserves of a bank got swallowed into a black hole… It would completely wipe those depositers out of the price system. Personally I think the case for deflationary recessions is stronger than that for inflationary, but from the fact I had to choose a black hole as an example, you can tell deflation of the monetary base is pretty rare.
If one bank lost all its gold reserves in a black hole, that is like, say, hurricane Katrina striking an area. Local resources have been destroyed, some people lost purchasing power. But it’s a real thing that happened, and everyone knows about it. So what has that to do with a business cycle? It will set the economy back if it’s large scale enough, sure. But that’s not a business cycle, that’s a simple setback.
As for deflationary recessions, those are rare indeed, according to Hazlitt in his book Inflation. They only happen when an outside event occurs, such as a decision by the govt to go back on the gold standard. Even then the harm caused is by people refusing to accept lower wages and prices for their goods and services. So they suffer, badly, till everyone comes to their senses and takes the [nominal] pay cut.
A discovery of gold in large amounts is different. There people can now spend more, but there is not more to buy. There has been no increase in productivity, just an increase in money. That starts a business cycle as people think they can now invest in something, since they have all that extra money, and usually invest in foolish stuff, tulips, dot.coms, houses. [Or as Mises put it, in projects that require plenty of resources that don’t exist]. So a boom starts until the market is glutted with something no one wants. [Or until the resouces are exhausted when the project is halfway done].
The ABCT is predicated on money expansion conducted through credit expansion, particularly in FRB systems (where the currency is legal tender and there is constant manipulation of interest rates, e.g. through OMO.) It relates to a mismatch between real resources in the economy available for capital expansion (savings) and new infusions in the money supply backed by … nothing and often several multiples of actual resources represented in banks (e.g. deposits.) It’s very specific and doesn’t apply to generic money infusions, which will cause some temporary dislocations in the economy but will likely dissipate quickly as market signals adjust (as they cannot right now.)
If the newly found money is directly loaned away (and I don’t see how on earth it could be)yes, if not you only get a distorted market and a redistribution of wealth but no business cycle.
Hm, I believe by the time the new currency has gained widespread acceptance both prices, exchange rates and interest rates have had plenty of time to adjust. In practical terms I don’t think one would even be able to notice any effect at all. Such is the Regression Theorem of the value of money, that it requires a long time for anything to become currency.
Depends. Lets make the case for an inflow in foreign currency brought about by the other country’s inflationary policy. Does our country has fully flexible (i.e. no public institution is allowed to purchase and sell foreign currency at all) or pegged (or semi-pegged) exchange regimes? If exchange rates are flexible, the massive inflow of money will be promptly reflected in a massive fall of exchange rates, thus neutralizing the net effect, while a pegged regime would force our own government to match the inflow with inflation, thus causing a cycle.
While if the inflow is not inflationary but reflects a true FDI flow, than you will have a boom, but not a bust as the investments that are being crated are financed through real capital, and any fall in the interest rate is real.
Nope, as whatever investment is made to fulfill the demand for goods to be paid in IOUs is actually going to repay itself, when the IOU comes due. The cycle happens because suddenly many IOUs turn out to be fake, defaulting. Without inflation, entrepreneur could hardly see 50% of their debtors default at once.
Impossible. If the increase is either modest or modestly fast (as it can only be), than all prices will have plenty of time to adjust. But even in theory, a sudden doubling of velocity would be near to neutral, i.e. leaving the structure of prices untouched. So, I don’t se how on earth could velocity change in order to affect interest rates before anything else.
It causes a set of consumers to become disconnected from the system, leading to (apparent) malinvestments which were predicated on those people having gold. The mis-allocation of resources is going to be on the final consumer side rather than capital investment side.
Couldn’t the opposite happen? A large portion of gold reserves being wiped out could cause people to be temporarily frugal with their money, leading to underinvestments?
Yes there is a difference between simply putting more physical currency into curciulation and lowering overall interest rates. I agree it would dissipate quickly, and misalocations would be ironed out, but would this not be a mini-business cycle?
I think he’s playing semantics here… misallocation and misjudgement are all parts of business cycles.
" I agree it would dissipate quickly, and misalocations would be ironed out, but would this not be a mini-business cycle?"
There are several key characteristic features that are part of the complete ABCT put forward by Mises, and further elaborated on by Hayek, Rothbard, etc… that are completely absent in the scenario of infusion of newly discovered gold that finds its way into a 100% reserve (or near 100%) banking system:
There is no liquidity crisis that takes its form by a pervasive wide-scale banking crisis. So the typical “Bust” usually associated with boom/bust cycle is absent.
There can be no monetary contraction that results from any previous monetary expansion during the boom. Monetary contraction, the major driving force behind the threat of acute price deflation, is practically impossible.
The nature of the loans is also different. The newly discovered Gold is voluntarily saved by its new owners. The resources that are potentially made available to finance the new investments are those resources that the new gold owners would have consumed if they had not saved the new gold. Now, it’s true that as prices are are bid upward, the savers may realize that they don’t want to save as much and decide to not reinvest some of the Gold. In this sense, and in this sense only, there may be a temporary drop in the interest rate followed by rise again after prices adjust.
Can’t the physical loss of banking reserves cause a banking crises? irl it would be local, but isn’t the principle the same?
This is for the case of a boom caused by artificial credit expansion, but introducing new fiduciary media in some arbitrary way (printing press, gold meteors) would not cause a monetary contraction.
"Can’t the physical loss of banking reserves cause a banking crises? "
No because all deposits are backed by 100% gold. There are no IOUs pyramided on top of some base reserves. All liabilities and assets are matched. Sure, entrepreneurs and capitalists can incur losses but there is no longer any pyramid of debt that can collapse. All investments are supplied by sound financial instruments such as stocks, mutual funds, bonds, time deposits, etc…
“but introducing new fiduciary media in some arbitrary way (printing press, gold meteors) would not cause a monetary contraction.”
By some sort of fiat money, sure. But that’s not fiduciary media. If government scraped the modern credit system and issued all loans itself by creating fiat money on the spot, then #1 and #2 wouldn’t apply either. However, those loans could never correspond to the level of real voluntary savings and a continuous inflationary policy would create all of the same intertermporal distortions that the present system creates. If not halted, it would lead to a breakdown of the currency, and if it is halted, there would be a slump and a correction phase minus the usual banking crisis. Creating fiat money on the spot for every loan would be simply like bailing out the system in advance.
If the gold reserves are lost, then there are unmatched liabilities. Moreover, even without a banking system, the loss in purchasing power of some consumers temporarily invalidates any investments predicated on those consumers.
Or a sudden influx of gold. It would result in the propieters having more purchasing power on the market than anyone expected; outbidding non-recipients of the new money. Although, taking this logic to its conclusions, we observe that large increases in any commodity could have this effect. The purchasing power of the owners of a new gushing oil field is greatly increased in the same way. They “sell oil” to increase their bidding power on the market, the same way you “sell gold”.
This is probably an invalid way of looking at things… though intuitively right now I don’t see why viewing everything through the perspective of a monetary base (fiat, gold) is the only correct viewpoint. I don’t see why it has to be a special class of goods. After all, most things can still be traded and no money is accepted everywhere.
I think at the end of the day, markets can’t predict all possible futures, such as the kinds of wierd black hole/mana bubbles we’re discussing, though they have the means to do so most rapidly.
“If the gold reserves are lost, then there are unmatched liabilities”
The gold is stored for safekeeping in the 100% reserve bank. There are no “unmatched liabilities” , for every deposit can be redeemed in full. There is no liquidity crisis. The amount of demand deposits is equal to the amount of specie available should all the depositors come forward and claim their money.
As far as the people who have saved the gold and have voluntarily made it available for investments, the various financial tools that are available (outside the fractional reserve bank) are never based their practice of maturity mismatching. The business man must plan so that his assets and liabilities are matched. Of course, he may fail in meeting his full obligations due to losses, but that’s due to entrepreneur error and not a practice of mismatching.
“Or a sudden influx of gold.”
Correct, however as I said before, it most probably would lower the interest rate temporarily before it rises again after the price structure is altered. But it is simply too much to jump from here to saying that it is the same as a credit expansion and that it will cause all the “evils” of ABCT. Here is another difference to consider in addition to the differences I’ve mentioned in the previous post.
As hayek often stressed, remember that to keep the boom going, you need to accelerate the rate of new money, precisely because entrepreneurs will begin to adjust their expectations. So generally speaking, unexpected “acceleration” of influx of new gold is highly unlikely.
Also, let’s remember to put this “problem” of influx of new gold in perspective. It was Larry White himself, who had written and lectured about how the most famous and largest instances of discoveries of new Gold in the past, produced an inflation rate that is practically laughable to anything we have today on a normal basis.