The Great Debate: Half-Truism

"There are those who say that he cure for inflation is deflation.  And... there are those, though they are few, who say that the cure for the man who has been run over by a motorcar, is to have the same motorcar run over him in the opposite direction." - Ludwig Von Mises, Lecture on Inflation, 1968

Broad definition…  narrow definition…  it is readily apparent the broader definition is what I am referring to here. But one must remember that I am actually no longer using Mises’ definitions at all. I am defining money as it relates to the commodity competition… not its nature.  I call it fiat money not because it has government force behind it, but because it is that government force that makes the commodity win the commodity competition and therefore become the money.  Credit money doesn’t exist at all in physical form and thus doesn’t compete in the competition and is not actually money. 

As you have noticed by now these responses are coming slower and slower.  That’s because, by the very nature of the problem, as we drill down, more and more remedial teaching is required.   There is a knowledge base that is required to understand these points… and we must first make sure the reader has it.

So as is my way… I will begin by explaining some concepts.  Oh I know you know what borrowing is superficially but nothing about money is superficial.  When one takes out a loan, he has time-shifted purchasing power.  He has taken purchasing power from his own future, and moved it to the present.  This creates a corresponding reduction of his purchasing power in the future, which is larger than the amount he moved.  The difference is the interest.

The mechanism for this is a promise to pay.  Is this clear?  You don’t have the money now, but in the future you will and you promise to pay it then. 

Mises and Vox point out that that time-shift isn’t actually the miracle here.  The miracle is that the credit money created by the time shift is accepted exactly like actual money .   No flux capacitor required.

What is important to note… and what Vox is missing… is that it when the credit money is created by time-shifting like this is not considered inflationary.  The interest is rewarding those who have saved, and it all washes out in the end.  The interest rate, which is the price of time-shifting money, fluctuates as demand for time-shifting increases and decreases… and that.. all by itself… mitigates the boom and bust cycle created by the lending.  As more people borrow, the price of borrowing goes up… bringing that number back down.  As fewer people borrow the price is lowered so more will borrow… bringing the number of borrowers back up.  We find a happy medium where the interest rate is moving around, but the purchasing power is relatively stable.  The risk banks take when leveraging money also influence that price… which we call the interest rate. All of this works together nicely.  Which is why when Mises talks about inflation he always talks about government. 

That is how it is supposed to work.  And when its working like that… we can look at the amount of money in a given account that exists above and beyond the deposits in that account and we call it credit money.  Because it exists above and beyond the deposits in the account, it has no physical representation.  The coins, or dollar bills, do not exist.  I need you to be clear on this.  I have a checking account with say…$45,000 in it.  If I go to the bank and ask them for $45,000 in cash… they will laugh in my face.   However, debit cards are swiped, and the credit money is accepted exactly like cash is accepted.  That is the miracle.  And it is a miracle… of faith. 

But what about the business cycle you ask?  Well things are always going to move around a little because price is a reactive force.  But in order to create the large fluctuations that really do damage, well, you need the government for that.  And when you have government interference, you have what Vox calls, the broad definition of fiat money.

So now that we understand borrowing and lending we can discuss what is wrong.  And what is wrong… is the central bank.   Central banks break the link between savers and lenders.  Rather than the deposits being the source that creates the leverage, you now have a central bank that is merely using the deposits to rationalize its decisions to expand credit.  The deposits of savers are reduced to mere justification.    

The central bank sits on high, and manipulates the interest rate… which eliminates its ability to mitigate the booms and busts of the business cycle.  Then on top of that… the evil bastards then set themselves up as the Credit Gods… passing out credit as they see fit… attempting to manage an economy every bit as much as the communists ever did, and failing just as spectacularly.

If you get nothing else… I hope and pray you grasp that. 

I also need you to understand that you cannot have a central bank if you don’t have a government interfering to create one.   That interference in the market alone is enough to meet Mises standard of the broad definition of Fiat Money… which… if Vox had bothered to ask… I would’ve explained.

So if you have made it this far you now realize that the money in your checking account doesn’t actually exist.  its not that the banks just don't keep that much cash stored.  There isn't that much cash in existence.  Not even close.  

So now that the terror has sunk in… what is the urge that you’re squelching down right now?

Is it the urge to go borrow more money?  Or is it the urge… to go get your cash and stick it under your bed?

Exactly.  And now you see why Vox’s measure of the money supply is incorrect.   M1 is the real money.  M2 and TSM2 are close approximations of the purchasing power currently available… though obfuscated through shenanigans.  Z1… well Z1..  Is just a measure of claims on money.  It doesn’t reflect a limit on new future claims.  At best it can serve as an indicator of how much new credit money is being created.  Z1 will never be able to show deflation.  That’s because Z1 doesn’t show a credit limit… it shows a credit balance.  See if I have a $5000 credit limit on my credit card… and I owe $5000… then my credit card is showing up as $5000 on the Z1 report.  If I pay my credit card down to a balance of $2000, then my credit card is showing up as $2000 on Z1 which Vox would then say is a reduction in purchasing power of $3000.  This is incorrect.  My high credit is still $5000.  I can go spend that $3000 in credit money any time I want to.  Z1 is certainly a valuable tool, but it is a limited one.  Now… as has been said… one cannot print borrowers… so if the rate of credit growth is slowing, or going down instead of up it can mean bad things…for example the delivery system for new credit can be interrupted.  That said, if one considers the nature of the financial abomination that we have before us, I can certainly not fault Vox for going that way.  However, It is not where I go.

So… Cash is what you want.  The whole reason credit money works, is because there is a faith-based link from that credit money directly to cash.  Thus, the money, right now, is cash.  What you’re seeing is precisely what happened in the Great Depression.  People wanted their cash.  They hid it inside walls and buried it in jars.  Banks collapsed destroying massive amounts of credit money, but folks still wanted their cash.  But Vox fails to recognize a critical underlying difference between then, and today.  He looks at those in control… the government and the central bankers… and he sees them expanding credit.  He understands the system better than almost everyone, including the central bankers, and thus he uses that understanding to predict how the system will behave.  He expects it to behave the way it behaved in the 1930s. 

But there is something happening further down on a deeper… more basic level that Vox is failing to recognize, that is different.  It was only in recognizing that difference that I retro-actively understood Mises' error in categorizing money.  

Before we go there though… we need to back up one more time to Subjective Value Theory.  Remember last time I reminded you that subjective reasons are still reasons right?  Well that’s one aspect of SVT but there is another more basic aspect… and that is… we measure value comparatively.  We compare the value of this to the value of that. 

Let’s look at a standard ruler.  How long is it?  Its twelve inches.

Excellent.  Now what if we redefined the length of an inch so each inch was actually smaller?  Bloody hell now the ruler is 20 inches long!  But the ruler hasn’t grown.  The subjective way we measure the ruler has changed. 

Are we clear on that?  The ruler’s physical characteristics did not change.  How we measure it changed.

So Nate.. now are we ready to move forward?

No.

No I have to take you back again to the competition which Vox , to his peril, ignores.   So we have these commodities battling it out in a competition of demand.  Not supply.  Demand.  The one most in demand wins and becomes the money.  The demand is the key.  People want that commodity.  They want it badly and everyone knows they want it badly.  So because everyone knows they want that commodity badly... everyone knows that they will be able to trade that commodity.  They have faith… faith friends… that they will be able to exchange that commodity in the future for other goods and services they require.

That’s all good and well if we’re talking about something like Gold or Platinum or Silver.  People want it because of what it is… and what it is will not change.  But fiat money?  Well… they want it because of all manner of government related enhancements.  If it weren’t for those enhancements… they wouldn’t want it at all.  But those enhancements exist…  so long as the people have faith in that government. And that is why I define it as fiat money.

There is much more to say… but I fear I’ve given you to much to digest already.   I will be addressing the key difference between today, and the American 1930s in my next post in this debate.