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Let's say that in the counterfeiting example, the counterfeiters pumped $300 billion a year of counterfeit bills into the economy. The counterfeiters spend all

Let's say that in the counterfeiting example, the counterfeiters pumped $300 billion a year of counterfeit bills into the economy. The counterfeiters spend all this money on wine and women. When the counterfeiters are found out, this $300 billion dollars of demand for the vineyard and brothel industry evaporates. That will cause much unemployment. I agree with you that this should be allowed to happen. The workers in those industries must find new jobs that are economically productive. The government should not step in and start printing money to prop the brothels up, as this will simply create zombie industries as Giles noted. (Nor can the Giles recover the lost wealth - the counterfeiters already spent the money, the resources that went into producing the wine and woman have been consumed). But there is a second cause of unemployment, which is the unnecessary collateral damage caused by the deflation. When half of the money supply evaporates, people's savings to expenses ratio are now at dangerously low levels. So they start reining in expenses. But all expenditures are another person's income, so business revenues fall. In theory, the businesses could drop their wages and prices an equivalent amount, and eventually you would get a pigovian rebalancing effect. But the trouble is sticky labor and, more importantly, debt contracts. When revenues fall, the businesses cannot pay debts, they go bankrupt, people are unemployed, and you get a full fledged deflationary spiral. Millions go unemployed, not because they were not building something people wanted (they were), but simply because contracts rely on a steady money supply, and when money supply drops by 50%, all contracts get shot to hell. There are two solutions: one, the government could announce that in light of the discovery of the counterfeit bills, all contracts will be redenominated at a 2:1 ratio - thus debt contracts will be cut in half, wage contracts cut in half, NFL salary cap cut in half, leases cut in half, etc. Or, the government could announce a one month window in which people can trade in their counterfeit bills for real ones. This will restore the money supply to the original levels. Either one of these solves the problem instantly and completely avoids the depression. There are no zombie industries, everyone just continues with their productive pursuits. The only unemployed people are at the vineyards and brothels, they must still find new jobs. Of course, if the government decides to restore the money supply by printing money and giving it to government workers digging ditches, then you will still get massive frictional unemployment, and you'll permanently reallocate resources into useless activities. This is the Keynesian/Obama solution and it's a terrible one. The problem you, Giles, and the Austrians have is that you do not distinguish the unemployment caused by necessary restructuring ( the brothels and vineyards) from the unemployment caused by a fall in the money supply and the wrecking of contracts. The first cannot and should not be avoided. But you can, and should, prevent the collateral damage that creates a great depression. Until you see the difference between these two types of unemployment, you guys will get killed in debates with the Keynesians, and no one will listen to you. Which is too bad because the Austrians have a lot of great insights, and the Keynesians are awful on a lot of other points.

gills 18y ago
I see your point about unemployment, but I'm going to play the devil's advocate for a moment anyway. I didn't distinguish between causes of unemployment in my post because the market doesn't care. Does it? "all expenditures are another person's income"; We agree here. It is unlikely that the 1/2 of the economy previously paid for in counterfeit bills was all wine and women. The money they earn is spent and flows into other parts of the economy, creating phantom demand in, effectively, all sectors. A properly functioning market, by definition, knows how to trim the phantom demand from all sectors immediately and reallocate the remaining capital. This is the path of least collateral damage. Government distortion of the market process (in the form of monetary policy and failure to universally enforce existing laws) prevents market participants from perceiving that which will have value going forward from that which will not; when that happens, the only self-preserving course of action available to an individual investor is to take his or her money and go home until the smoke clears. That disorderly pseudo-market behavior is what really causes most of the deflationary collateral damage, because even the most solid players in the strongest sectors get torched. Read that again -- compare it to the market behavior the past few months. That is the part of the spiral we're in. Until the government enforces existing laws universally and removes it's monetary distortions from the markets, private capital will stay in the proverbial mattress -- which makes all this Keynesian-vs-Austrian monetary policy talk into just a bunch of masturbation.
- bokonist 18y ago
  * The money they earn is spent and flows into other parts of the economy, creating phantom demand in, effectively, all sectors.* No, only the money spent near the entry point into the market is distortionary. The counterfeit money that was created five, ten, twenty years ago, acts like any other money. Think of it this way, imagine the counterfeiting had stopped fifty years ago, but the counterfeit bills had remained circulating for all that time. Are they causing distortions? No they are not, at this point they are just like any other bill. Likewise, if you are on a gold standard, it does not matter whether the gold was original stolen from the Incans hundreds a year ago. Once it's in circulation for a while, its origins do not cause distortions. Or think of it another way. The vineyard and brothel workers spend their counterfeit bills on food, rent, and movies. Let's say the inflation stops. Now, seniors with savings have more money to spend, since they are not losing money to inflation each year. So they spend more on travel and nursing homes. The brothel workers now find jobs on airlines and in nursing homes. What do they spend their wages on? Food, rent, and movies. Thus the demand for food, rent and movies was perfectly real. Only the demand for brothels and vineyards was false. A properly functioning market, by definition, knows how to trim the phantom demand from all sectors immediately and reallocate the remaining capital. This is the path of least collateral damage. This is simply not true. Remember, the government already injected itself in the free the market when it declared Federal Reserve Notes as the standard fiat currency across the land. Every market contract is written assuming there are are $10 trillion Federal Reserve Notes in the world. Every entrepreneur assumed $10 trillion in notes when they planned their years production. Thus when the Federal Reserve allows the money to supply to drop in half, it is creating a tsunami sized market cataclysm. Like it or not, the government instituted fiat currency many years ago. It made a promise to the market that it would not allow hyperdeflation or hyperinflation. This is not only a promise, it's also good policy. If you are going to run a fiat currency, you should keep your dollars like gold - make the quantity as stable as possible. The market wrote its contracts based on that promise. The government needs to keep its promise, otherwise it will throw the markets into chaos as every contract gets totally fubarred. That is the part of the spiral we're in. Until the government enforces existing laws universally and removes it's monetary distortions from the markets, private capital will stay in the proverbial mattress -- which makes all this Keynesian-vs-Austrian monetary policy talk into just a bunch of masturbation. You are simply wrong on the facts. Much of the private capital as simply evaporated. People refuse to trade their dollars for stocks or bonds because in a massive deflation stocks and bonds are bad bet. Dividends are falling, companies failing, bonds are defaulting. The basic problem is that there only $2 trillion actual Federal Reserve Notes in the world, but before the crisis there were $100 trillion assets in the world. The is an extraordinaryly high ratio. The only reason this ratio got to this point is through a lot formal asset guarantees ( FDIC, treasuries ) and informal guarantees ( Greenspan put, "too big to fail", government encouragement of 401ks, FreddieMac, subsidized loans for homeowners, being complicit as regulated funds put money into AAA bonds, etc,etc). Essentially, the government was winking and nodding as Wall St. pumped counterfeit bills into the economy. When Lehman failed, the government basically said, "Actually, these counterfeit bills are not tradable for Federal Reserve Notes." Then there was a panic as everyone dumped their money market funds and stocks in order to get their hands on FRN's, treasuries and FDIC insured bank notes. The Federal Reserve saw the panic, realized that this could cause cataclysmic deflation, and started guaranteeing assets. Now, I do not approve of a lot of the government's policy. The "stimulus" is awful. I think they should also stop propping up zombie banks. Home prices need to fall, GM needs to renegotiate its obligations. What the government should be doing is preventing deflation in the most non-distortionary ways possible, such as back stopping the money market funds, declaring a payroll tax holiday and funding it with printed money, or even just mailing every American some newly printed bills. Or if you want to do a clean reboot of the whole thing once and for all, you could try Plan Moldbug: http://unqualified-reservations.blogspot.com/2009/01/gentle-introduction-to-unqualified_29.html http://unqualified-reservations.blogspot.com/2009/01/gentle-... If you were running the Fed, you would you remove the backstop on the money market funds? Why? What do you think would happen if you did?

gills 18y ago

I see your point about unemployment, but I'm going to play the devil's advocate for a moment anyway. I didn't distinguish between causes of unemployment in my post because the market doesn't care. Does it? "all expenditures are another person's income"; We agree here. It is unlikely that the 1/2 of the economy previously paid for in counterfeit bills was all wine and women. The money they earn is spent and flows into other parts of the economy, creating phantom demand in, effectively, all sectors. A properly functioning market, by definition, knows how to trim the phantom demand from all sectors immediately and reallocate the remaining capital. This is the path of least collateral damage. Government distortion of the market process (in the form of monetary policy and failure to universally enforce existing laws) prevents market participants from perceiving that which will have value going forward from that which will not; when that happens, the only self-preserving course of action available to an individual investor is to take his or her money and go home until the smoke clears. That disorderly pseudo-market behavior is what really causes most of the deflationary collateral damage, because even the most solid players in the strongest sectors get torched. Read that again -- compare it to the market behavior the past few months. That is the part of the spiral we're in. Until the government enforces existing laws universally and removes it's monetary distortions from the markets, private capital will stay in the proverbial mattress -- which makes all this Keynesian-vs-Austrian monetary policy talk into just a bunch of masturbation.

bokonist 18y ago
* The money they earn is spent and flows into other parts of the economy, creating phantom demand in, effectively, all sectors.* No, only the money spent near the entry point into the market is distortionary. The counterfeit money that was created five, ten, twenty years ago, acts like any other money. Think of it this way, imagine the counterfeiting had stopped fifty years ago, but the counterfeit bills had remained circulating for all that time. Are they causing distortions? No they are not, at this point they are just like any other bill. Likewise, if you are on a gold standard, it does not matter whether the gold was original stolen from the Incans hundreds a year ago. Once it's in circulation for a while, its origins do not cause distortions. Or think of it another way. The vineyard and brothel workers spend their counterfeit bills on food, rent, and movies. Let's say the inflation stops. Now, seniors with savings have more money to spend, since they are not losing money to inflation each year. So they spend more on travel and nursing homes. The brothel workers now find jobs on airlines and in nursing homes. What do they spend their wages on? Food, rent, and movies. Thus the demand for food, rent and movies was perfectly real. Only the demand for brothels and vineyards was false. A properly functioning market, by definition, knows how to trim the phantom demand from all sectors immediately and reallocate the remaining capital. This is the path of least collateral damage. This is simply not true. Remember, the government already injected itself in the free the market when it declared Federal Reserve Notes as the standard fiat currency across the land. Every market contract is written assuming there are are $10 trillion Federal Reserve Notes in the world. Every entrepreneur assumed $10 trillion in notes when they planned their years production. Thus when the Federal Reserve allows the money to supply to drop in half, it is creating a tsunami sized market cataclysm. Like it or not, the government instituted fiat currency many years ago. It made a promise to the market that it would not allow hyperdeflation or hyperinflation. This is not only a promise, it's also good policy. If you are going to run a fiat currency, you should keep your dollars like gold - make the quantity as stable as possible. The market wrote its contracts based on that promise. The government needs to keep its promise, otherwise it will throw the markets into chaos as every contract gets totally fubarred. That is the part of the spiral we're in. Until the government enforces existing laws universally and removes it's monetary distortions from the markets, private capital will stay in the proverbial mattress -- which makes all this Keynesian-vs-Austrian monetary policy talk into just a bunch of masturbation. You are simply wrong on the facts. Much of the private capital as simply evaporated. People refuse to trade their dollars for stocks or bonds because in a massive deflation stocks and bonds are bad bet. Dividends are falling, companies failing, bonds are defaulting. The basic problem is that there only $2 trillion actual Federal Reserve Notes in the world, but before the crisis there were $100 trillion assets in the world. The is an extraordinaryly high ratio. The only reason this ratio got to this point is through a lot formal asset guarantees ( FDIC, treasuries ) and informal guarantees ( Greenspan put, "too big to fail", government encouragement of 401ks, FreddieMac, subsidized loans for homeowners, being complicit as regulated funds put money into AAA bonds, etc,etc). Essentially, the government was winking and nodding as Wall St. pumped counterfeit bills into the economy. When Lehman failed, the government basically said, "Actually, these counterfeit bills are not tradable for Federal Reserve Notes." Then there was a panic as everyone dumped their money market funds and stocks in order to get their hands on FRN's, treasuries and FDIC insured bank notes. The Federal Reserve saw the panic, realized that this could cause cataclysmic deflation, and started guaranteeing assets. Now, I do not approve of a lot of the government's policy. The "stimulus" is awful. I think they should also stop propping up zombie banks. Home prices need to fall, GM needs to renegotiate its obligations. What the government should be doing is preventing deflation in the most non-distortionary ways possible, such as back stopping the money market funds, declaring a payroll tax holiday and funding it with printed money, or even just mailing every American some newly printed bills. Or if you want to do a clean reboot of the whole thing once and for all, you could try Plan Moldbug: http://unqualified-reservations.blogspot.com/2009/01/gentle-introduction-to-unqualified_29.html http://unqualified-reservations.blogspot.com/2009/01/gentle-... If you were running the Fed, you would you remove the backstop on the money market funds? Why? What do you think would happen if you did?