Monday, August 8, 2011

Irrational Expectations

Of all the irrational things we do and expect on a regular basis, and there are many, one just keeps on popping up again and again on blogs I read and in the comment sections. The thing is, I think I may be the only one who sees it as irrational. Ive never seen anyone else comment on it nor has anyone ever responded positively to my comment/question when I make it. I think it is because it involves questioning that thing which everyone just takes for granted and never questions. Its never even entered their mind to question it. Its the idea of interest on saving. Saving, it seems to many, is what defines a rational/good/responsible person. "Save some for tomorrow". "Dont use it all up today". "You dont know what tomorrow brings". These are all true/rational statements. So where is it I take issue? Not with the act of saving itself, because I save plenty, but with the idea that MY saving is necessary and as a result I should be paid handsomely for my saving. In fact, it seems to be posited by all, when I save (an act which helps me) I should be rewarded with not only access to the level of present consumption I decided not to do, but I should have the opportunity for MORE consumption later. And if that condition doesnt exist when I decide at a future date of my choosing? I get to curse our government (they are always to blame) and cry INFLATION INFLATION!! I find the whole exercise quite odd and I hope to show that its quite irrational.

Much of the discussions on econ blogs involves terms like nominal, real, medium of exchange, unit of account, credits, debits, interest and of course the big two.......inflation/deflation. All these terms refer to different accounting variables changing in relation to one another and of course accounting is how we keep track of, keep score FOR, money. Thats all accounting is. These numbers are supposed to represent real economic variables (real being sweat and atoms, ala Winterspeak) but often these numbers take on lives of their own and lose relation to real stuff. I want to argue that removing money and simply looking at real economic factors makes interest irrational, at least the levels that many people seem to think they should earn. Interest and by extension, I believe, extreme variations in wealth would be impossible in a barter world. Except by outright use of force, fraud or theft (Yes I know that probably explains the situation in our monetary world as well but........)

The most common place this idea comes to the forefront is in discussions of our public debt levels and the machinations of our federal reserve. People are concerned today that our low long term interest rates are punishing savers, exposing them to the woes of inflation, as our govt prints cheap money and makes their previously saved dollar worth less and less. Ignoring, for the purposes of this post, the whole flawed notion that most people have about exactly WHAT govt debt represents for the private sector (an asset or a liability), I want to just address the whole notion that someone should EVER expect their buying power to stay the same for a 10, 20 or 30 year period. Just exactly what does everyone else need to do in order for you to keep your buying power intact for three decades? Think about it. Today you have extra money and instead of buying 20 loaves of bread you buy 2 and save the money. Now you will likely be able to buy two loaves of bread a week for the next nine weeks, as the loaf of bread rarely changes prices significantly over 10 weeks, but if you keep that money for 5 years why should you expect that you could still buy 18 more loaves of bread with that money. If you can great, but why does the rest of the system have to operate in such a way as to guarantee it. And if the system doesnt do so, why is the system flawed? Now there are things that you might be able to do with that money to facilitate the likelihood of such a market price for bread. You could invest in technologies which make the harvesting of wheat more efficient or technologies which make the seeds grow more wheat per acre but if you dont, you have no gripe. This same discussion can apply to every product which you decided not to buy and instead saved your money.

Now, according to orthodox economists this is exactly what savers do. They put there money in places where the professionals make these decisions to keep the progress of capitalism moving, protecting the buying power of your dollar. Trouble is this isnt really true. Most of what we call investing is simply buying an already created commodity like a stock, or gold and waiting to find another sucker to buy it later at a higher price. This is the sole purpose of "investing" for most of us and this mindset is perpetuated if not outright demanded by the "professionals" who manage our money these days. Its simply gambling, waiting for the odds to move in your favor and then catch some poor sap in a losing position. Now of course in a world where people are only gambling their own money every winner is off set by a loser, its a zero sum game. But today we have large investment banks gambling OTHER peoples money where they stand to lose nothing (govt backing) and the others lose everything. Its not like your friendly high stakes poker game at all.

So lets remove the money and see what a saver is really doing and really expecting. A saver is simply deciding to only consume what they need right now and putting some aside for tomorrow. If they needed it they wouldn't save it. So how is it so noble to make the rational decision to only consume what you need? If they are lucky enough to have way more than they need what can they do? They either put it aside and use it before it spoils, deteriorates or is somehow not in the same condition it started and therefore not of the same utility or they find someone else who might can use it. Now if they have that someone else maybe they trade but there is never a guarantee that there will be someone else needing what you have extra of. But lets say you find someone who has none of what you have and would like some but they have nothing you need or want. What to do? You can invest in him and let him have it and work with him to help him return something to you. Your investment requires work on your part and your return is commensurate with the effort you put in to your investment. If you just say "here" and walk away you've given him something but you should not expect anything in return other than an in kind gift. No interest. If you would like some real returns down the road say one, two or five years ahead, you need to do something to bring that to fruition. Investment is an effort not a passive activity.

I remember being taught the "Rule of 72" a number of years back. The rule took the interest rate divided it into 72 and came up with the doubling period for your investment. 7.2% doubled every 10 years. 3% doubled every 24 years. Now of course this was just "nominal" doubling. This didnt necessarily reflect twice as much real stuff being created and that is the point. How could we ever set up, endorse, encourage and continue to genuflect towards a system which says it can double in size in every 10 and 20 years....... forever!? Is this not madness? Is it not being designed to fail? We could never have these expectations in the absence of money. In the absence of an abstraction which purports to represent real activity but in truth is becoming totally detached from real activity.

In the previous example of loaves of bread. Would it be rational for someone to lend a loaf of bread to someone and expect 2 in ten years? Maybe. Could everyone expect that? No. Especially not into perpetuity. If you wait 20 years you would expect 4. 30 years you would expect 8. It becomes obvious using real stuff that these interest returns are irrational expectations.

So if there is something you want, get it now. Dont save the money and expect to be able to get IT or its equivalent in 5 or 10 years, not unless you make an active effort yourself to try and ensure such a thing. Its like the girl you had the opportunity to marry when she was 21 beautiful and wanting to marry you. At 30 she may be fatter, she may have let her complexion go OR she may be more beautiful than ever but love someone else now.

Save when you dont need everything you have but dont expect the rest of the world to make sure you can get what you want later. It dont work that way

Saturday, August 6, 2011

An Austrian a Monetarist and a Chartalist walk into a bar (a thought experiment)

Thought experiments can be very useful and powerful tools. Designed to make you consider things you've never considered before they ask you to question orthodox ways of thinking. Its easy for us to just go with what we think we know. Much of what we know isnt really known, in the sense that its a proven fact. It just functions as a working definition of the reality we find our selves in. Agreed upon conventions function as knowledge until something comes along which upends that convention. When what we thought we knew cant explain a new set of circumstances we are in a quandary. Do we do the work to reexplain the circumstances or do we tell a convenient story which satisfies us and allows us to move on? The first response is hard the second can simply be the product of a creative mind.

The current economic situation has given us much fodder for debate and many areas where we should question things we've always understood to be true. A prime area is the nature of money. How did money or does money come to be? There are some varied historical explanations which revolve around barter societies discovering money on their own and stories about a state making the determination what will be used as money. I find the state theory of money more persuasive but I certainly cant say the evidence settles it.................historically. I do think that regardless of where you stand on the historical evolution of money, today states play a very large role in determining somethings degree of "money-ness" .

What I want to do here is look at how an Austrian a Monetarist and a Chartalist might design their monetary system from scratch, say after forming a new country that has seceded from the USA. I hope to show some of the questions that would need answering and different ways of answering them.

First how an Austrian might approach it. Professor James Galbraith is talking to Rick Perry the newly elected president of RUSA

PG- So Governor Perry , congratulations in advance of becoming president of your new country. It must be quite thrill !

RP- You betcha! (guess who his VP is)

PG- Well the first question I have for you sir, since I'm an economist, is what are you going to use for money in your country?

RP- We're gonna use gold! Thats what Mr Paul suggested. We are going to have sound money here, none of that "out of thin air stuff"

PG- The gold standard was abandoned over 40 years ago by almost all developed nations, are you sure that is the directon you want to take?

RP- Absolutely! Gold is the only true money. Paper money is worthless. What are you going to do with it in a crisis, you cant eat it!?

PG- Being able to eat your currency is not a standard I think we should adhere to but if we do gold fails in that regard as well....does it not?

RP- Well........ uuuhhh.... yeah .... I guess thats true......... but gold has been money for thousands of years. That should mean something, huh?

PG- Well I could argue about golds moneyness but that may be a discussion for another time. In order for you to enact a gold standard you are going to need to have some gold in your countries coiffers. How much do you think you'll need for the 100 million people who decided to stand with you in your new country?

RP- I dont really know. I think Ron Paul has all that information he's the gold expert.

PG- Well, I can tell you that you are going to need a lot. A lot more than the citizens of this country likely own...... And you are going to have to convince them to part with it as well. The whole purpose behind a gold standard is that your money is backed by gold. You are telling your citizens "if you wish to you can trade X amount of your currency for Y amount of gold". This way they are content that they can get something for their money. It lets them sleep at night....... so I've heard. A critical part is that the govt has to have the gold , not the people, at least to start. You are going to need to acquire the necessary gold somehow.
How will you do it? What will you use to buy it?

RP- Cant we just use our dollars? Me and my buddies have lots of them.

PG- Well yes you can but gold is over 1500 dollars an ounce. How much money will it take to buy the necessary gold? Dont forget too that as soon as you and your buddies move to acquire all the gold you'll need, the market price will continue to go higher. It will not be a cheap undertaking. I dont think there are enough dollars to buy what you'll need. Starting a country and a currency system is a very broad undertaking, there are lots of things to consider. I dont think a gold standard is the way you should run this.

RP- Ron will be so disappointed if I dont, he really was looking forward to reestablishing this country as an economic superpower and he says only a sound money system will get us there.

PG- How you run your money system is very important I agree, but a gold standard will take your eye off the ball. I strongly suggest you abandon that idea.

RP- What do I do then?

PG- You need your own currency that is not at a fixed parity with any commodity or any other currency. It is a floating exchange rate determined in the markets and related to the productiveness of your people. You need to promise your citizens nothing in exchange for their currency, other than the ability to pay off tax liabilities.

RP- TAXES!? WE wont have any taxes HERE!!.

PG- You need some way to get your new currency in use. Why else would they use it if they must pay no taxes with it?

RP- Well, its our national currency, theyll use it because they are patriots!

PG- Maybe for some time but if they do not NEED to, eventually you will find folks developing their own currencies. Whats to prevent your banks from issuing their own private currencies?

RP- I'm not sure I want to prevent banks from issuing their own private currencies. That sounds like a good thing to me.

PG- Well, there are some potential problems with every bank having their own currency. You'd have many prices on things, Some people would be paid in one banks currency while others would be paid in another banks currency. Having one currency for your country offers some very real advantages and makes much of economic life more hassle free. Even if you go the private multiple currency route you are still left with the problem of how banks acquire and what they use as capital. All banks need capital in order to function. What will banks in your country use as capital?

RP- What do they use as capital now in the US?

PG- The short answer is mostly dollars. Dollars which individuals use to buy initial stock in a bank. A bank is required to raise a certain amount of capital to be retained in the event of loan losses. Your country will likely require its banks to adhere to international standards in order for them to be perceived as legitimate and strong. So, your new countries' banks will need capital. They can use dollars, but remember the dollar isnt your currency. Do you want your banks capitalized with a foreign currency? How will your citizens react when their banking system is disrupted because some foreign entity debased their currency, making your banking system unstable?

RP- Cant banks use gold as capital?

PG- Yes, but remember gold varies in price every day. Having more than a small amount of gold as backing capital opens up great volatility to the banking system. And your banks still have the problem of acquiring the gold. Right now all your citizens still have dollars, but your new banking system cannot use dollars, or shouldnt use dollars. You dont control them and primarily you want control of your nations currency. You will need to set a date for exchanging dollars for your new currency. And you will need to set an exchange rate initially. Later the market will set the exchange rate for you.

RP- So I exchange their dollars for our "Tallers" and then what do I do with the dollars?

PG- Many options really. Use the dollars to buy stuff from the US that your country needs right now. Or take those dollars and buy US Treasuries with them. These treasuries can be a part of your national wealth. You can earn interest and redeem the dollars later. You can exchange those dollars for another currency and buy products from somewhere else like Japan or China or Canada

RP- Why cant I just do this thru a bank currency?

PG- You could but it is cleaner to do your govt transactions via a govt currency. Now there is no reason your private sector has to use your govt currency but they might find it more convenient. If they dont use the govt currency then they wont get any liquidity protections from a Central Bank. The banks and the depositors will be on their own. Depositors may not like the idea of losing all their money if a bank does stupid things. Depositors are not shareholders necessarily. Shareholders provide a bank with starting capital but depositors simply keep their money with you and hopefully take out loans with you. Your citizens have been used to living in a country with deposit insurance, you think they want to give that up?

RP-Probably not..... hmmmmmmmm. But a Central Bank? I'm not sure we're going to have one of those. Ron has been an "end the fed" type ya know. He thinks it causes more problems than it solves.

PG- Thats a debate that may be worth having, but realize that the world you are operating within has central banks. Every other country you will be doing business with has one. There ARE some real advantages to keeping your settlement system working even when some banks are in trouble and having a lender of last resort can be advantageous as well. I would strongly advise having a central bank but the institutional arrangements of it and your Treasury are something you need to decide with your legislators.

RP- I'm still not sure about this govt currency stuff. We are free market people down here. That sounds too much like the old Washington bureacracy.

PG- Mr President, I think having a single currency is the best way to start and if its managed well all will be good. You may wish to create the conditions where alternative currencies can develop over time but I feel the best way to start is with one. There are places in some European countries that have developed some local currencies but it has been a gradual process.

RP- Well I thank you for your input professor but I'm going to have to defer to Ron on this. I'll tell him the points you've made but ultimately as Treasury Secretary its going to be his call.

The main points I want to highlight here are that even with a gold standard there are decisions which need to be made BY FIAT, at the discretion of someone given the authority. It seems to me a completely mistaken notion that a gold standard is something that promotes freedom of markets, honesty of currency and better possibilities for real economic growth. There are those who have said to me that there does not need to be an exchange rate with gold promised by the government in order to run a gold standard. My only answer to that is "REALLY!?". What has changed about a country who purports to run a gold standard yet promises you no gold in exchange for your currency if you so desire. That seems the WHOLE POINT of a gold standard.

Next I will explore, to the best of my ability, how a monetarist would approach this endeavor. I must confess to not fully understanding monetarism as it is presented in the blogs Ive visited like Scott Sumners "Money Illusion" or Nick Rowes "Worthwhile Canadien Initiative". I'm not even sure Nick Rowe places himself fully in the monetarist camp. Monetarism seems to be sort of a hybrid gold standard/full fiat type arrangement. It seems inordinately concerned with defending dollar values and as has been pointed out by TC so very well here, requires all activity to take place via the banking system usually through real estate lending. This is really how our current system is run for the most part, thanks to the Reagan revolution and supply side thinking.

The real flaw I see in it is that it runs all prosperity enhancing programs through our financial system (and prosperity degrading ones too). It purports to be free market but ends up being government subsidized money cartels squeezing the working class out of every penny of income. The thing is, this isnt a bug its a feature and the people defending are becoming more and more brazen in defending it. Financial markets are placed on unassailable pedestals while salaried workers are subject to cries of lazy, profligate or worse. I had inteneded a mock conversation like I had for the Austrian/goldbug view but really I dont think I can add anything. If you want to know why we shouldnt follow monetarism and have an oversized role of a financial system, look at the world today...... RIGHT NOW! Yes there are those who could argue that pure monetarism hasnt been followed and that is a point that I will concede, but pure anything has never been nor ever will be followed....... so grow up and get with the business of solving real world problems. Not making up pie in the sky theories that are of little practical use. You know the world has turned upside down when someone can accuse a theory of being "too literal". Sad. And he has a lot of people reading his blog who agree with him. Sadder


Now Id like to explore what a Chartalist would do if charged with developing a new monetary system.

Here we have Warren Mosler who has been appointed Treasury Secretary of the NUSA (New USA) and Neil Cavuto is interviewing him on Faux News.

NC- We have now as our guest Warren Mosler the Treasury Secretary of the New USA. Warren, you are finally getting what should be described as your dream job. You had a lot of...... shall we say.... "outside the box" ideas when you were just a regular guy with a blog and an investment company. Now you get a chance to show what you know about running a monetary system.

WM- Yes Neil. While Im happy and honored that president Sanders asked me to be in my current role, I wish that the old USA would have shown more willingness to explore my ideas I developed in my "7 Innocent Frauds of Economic Policy"
The old country could have avoided many of the problems plaguing it today. 25% unemployment, almost no growth and crumbling infrastructure.

NC- Aw cmon Warren. We've got corporate profits higher than ever, our workers are the most productive on the planet ..... now that we've got those damn unions outlawed... and gold is almost $3,000/oz. We have lots of very wealthy people, more than your country has. The only people not working are those who prefer drinking in a La-Z boy to doing my yard work.

WM- (Smiles)

NC- So what will you do different form the old country Warren?

WM- Well first off we are going to make a commitment to full employment and price stability in our country.

NC- How can full employment be guaranteed?

WM- Anyone who cant find work in the private sector will be in a bridge job that guarantees them a minimum wage with benefits until they can, if they wish, be re employed by the private sector. We would like everyone to be employed in the private sector, outside of the minimum needs in the public sector, but we recognize that there will be times when the private sector experiences rough patches and will lay people off. What we want to avoid are the downward spirals of GDP, and loan defaults that result from people losing income. Its not good for a banking system and has negative social effects when people lose their jobs and cant meet their obligations.

NC- How will you afford this? Taxes will have to be 90% I imagine...... what a nightmare.

WM- Affordability is never the question. At least not in the way you mean it. Our people now understand that our money is never available or not available. We have made a commitment to these values and we will simply fund them. No one else will be getting less of something they need just because someone else is getting income support. In fact, our people understand that these income supports keep their businesses healthy. People with incomes continue to come to your restaurant, your tire store, your hardware store or your software store. One persons employee is another persons customer. We only tax at a level necessary to cool inflation and our system is very flexible with very little income taxes and more taxes that are better thought of as demand regulators.

NC- I think this fast going to be a "You pretend to work we pretend to pay you" type scenario which was typical of the old USSR before Reagan showed them how to run an economy by lowering taxes and spending them into the ground!!

WM- Well, USSRs problem was less about not spending enough but more about trying to be the core producer and exporter to their sphere of influence rather than the US model which was about importing from all those that they settled with like Germany, Japan, Korea or Viet Nam. They had an unsustainable economic model.
We have no illusions about being the exporter to everyone nor do we wish to control our trade partners. We wish for all our transactions to be voluntary and we dont shoot for any particular level of Current Account balances. We know that what our trade partners do does not stop us from doing what we believe in.

NC- How long before you have unsustainable deficits and the rest of the world rejects your debt?

WM- Define unsustainable. We can run whatever level of deficit we want to reach our macroeconomic goals. We dont NEED anyone to "buy" our debt. If they wish to save in our currency we can make arrangements but we are in no need of them owning Treasuries. We still have to decide if we will even issue treasuries. The only reason we would is to drain reserves and maintain our FFR. We are leaning right now to having a zero FFR so no need to drain reserves.

NC- That sounds like something your banks wouldnt like

WM- Look, we dont have a banking system so we can have a government, we have a government that provides some support to our banking system. We intend to keep the hierarchy clear here. Our banks can make money by facilitating commerce, they dont need to just play in a bond market that becomes a government subsidized casino.

NC- So give me some specifics on some of the decisions you will be making in the next few weeks?

WM- Well we need to start our own currency so we can stay sovereign and not be tied to anyone elses activity, thats most important. So we need to determine when and for what exchange rate we will let our citizens trade dollars in for. All our banks will be recapitalized with our new currency and all goods will be priced in our new currency. We can help to set some prices by the wages we pay our government employees and by what we pay our domestic producers for the things our government is going to need.

NC- The govt is going to SET prices?

WM- Your govt does too NEIL. They set a wage by what they pay their employees and they contribute to prices for many goods
by determining what they will pay. Its not a mystery, its part of the power and responsibility of a sovereign currency issuer. We intend to be make sure our citizens understand these things. Our people will be less concerned about the size of government in monetary terms and more about impact in real terms.

NC- Not concerned about the size in monetary terms? You think they wont care about deficits?

WM- They will understand that they have control over deficits in as much as their savings desires will dictate to a large degree the amount that the government will need to spend into the economy. The more they wish to save the more we need to spend (or less we need to tax). We are going to have economically literate citizens, not a bunch of people inundated with mythology.

NC- No need to get ugly Warren

WM- Not intended as ugly Neil but the world was done a great disservice by the economics profession from the 80s til 2013.
Not understanding how to regulate banking activities and unnecessarily encouraging unemployment through their inflation fearing policies left a lot of people unnecessarily poorer than they could have been. We intend to not make that error.

NC- Well Warren we are out of time for now. I hope to talk to you in a year or so and we'll see who's economics is right!

WM- Thanks Neil


There is certainly much unexplored in this thought experiment but I do think this is a good start and hope others can add to this either in the comments or on their own blogs.