Whenever public spending is expanded in a disorderly manner – whether for real or supposed emergencies – it ends up being financed through expansive monetary policies at the cost of impoverishing the poorest and plundering the most productive. Nothing good ever came of that.
And it was always said that “this time it was different” as so many politicians – and economists – insist again today. But it is not. The future hidden cost, today as always, far outweighs the short-term benefits of the present. And as always, the weakest will pay.
This is a problem of economic theory. And to explain it, summarizing Böhm-Bawerk, I will say that starting from their subjective ordinal and dynamic scales of preference, individuals decide which trades to make and which not to make, so that in, a more or less, transparent market the prices at which the overwhelming majority of agents will trade will be established in an interval between the marginal valuations of buyers and sellers closer together.
This interval will move dynamically because the subjects’ subjective valuations and the factors that condition them are constantly changing. Those who are not willing to buy or sell in that range will be left out of the market, and will enter the market as long as the change in their valuations, the market price interval, or both, allows. Applying price theory to money would reveal that present money is exchanged for future money in the interval of an intersubjective interest rate that emerges from a process similar to that of prices. Similar but not equal, because all indirect exchange is of money for goods and services.
The utility of money is that of a universal means of indirect exchange. And if the price of all goods is expressed in money, the price of money – which is not the interest rate – we could only express it in goods, but we could not express it with reasonable precision in a basket or average of goods, because the scales of people’s subjective values are unstable. As Rothbard explains:
“Suppose, for example, that the money supply increases by 20 percent. As classical economics takes for granted, the result will not be a simple 20 percent overall increase in all prices. (…) Now, not all prices will simply increase by 20 percent because each individual has a different scale of values, a different ordinal ordering of profits, even the relative marginal profits of dollars and all other goods in his scale of values.
As each person’s dollar stock increases, his or her purchases of goods and services will vary according to the new position, they occupy in their dollar value scale. Therefore, the structure of demand will change, as will the relative prices and relative income from production, and the composition of the range of goods and services that constitute the purchasing power of the dollar will also change.
In a monetary economy, money is the only good that is in a state of barter with other goods and services, so in the present we do not have, nor could we have, a monetary price for money. Purchasing power, the concept with which we would identify a “price of money” is not equivalent to the price level in an index. But just because we can’t really measure it doesn’t mean it doesn’t exist. Purchasing power is a price of money in goods whose existence we all understand.
The problem that the marginal value of money was derived from its utility as a means of exchange and that in turn from its purchasing power, was solved by Mises’ regressive theorem in his “Theory of Money and Credit” of 1912. Rothbard summarized the marginal theory applied to money by Mises in this way:
“The relative earnings of money units compared with other goods determine the demand for cash balances of each person, that is, what portion of his income or wealth he will keep as a cash balance, compared with the amount he will spend. Applying to money the law of decreasing marginal (ordinal) profit, and taking into account that its ‘use’ must be reserved for future exchange, Mises implicitly arrived at a curve of decreasing demand for money in relation to the purchasing power of the monetary unit.”
This purchasing power, which Mises also called the “objective exchange value” of money, was determined then, as in the common and current analysis of supply and demand, by the intersection of the stock of money and the demand of a cash balance plan.” Mises finished the analysis by pointing out that the total money supply at any given time is neither more nor less than the sum of the individual cash balances existing at that precise moment. In no society is there money that does not have an owner: money always belongs to someone and therefore is always part of the cash balance of some individual.
And it is in this sense that fiduciary money is money, as long as the cash balances are deposited at sight, the extended circulating is money, and it is not difficult to understand that such fragile money is a money that exists only as a promise on a monetary basis much lower than the circulating one. All solid monetary policies must begin by this. That is the problem we are not seeing in time, in the midst of important political and economic urgencies in themselves.
The monetary policy of expansion that finances the disorderly fiscal expansion will disrupt the structure of capital more than the effects of the pandemic – and of the disastrous advance of interventionism taking advantage of it – with terrible consequences that will be paid for mainly by those who – today they are creating the future storm – claim to protect with what they do.
The expansion of credit – which finances the disorderly expansion of spending – will disrupt the structure of capital more than the pandemic, and the consequences will fall mainly on those who – who are creating the future storm today – claim to protect with what they do. This is a problem of economic theory. Nor is it true that there was no other way. Nor that the best was done.
There was another way and the worst possible was done. The consequences will come – for the United States and the world – in the worst possible circumstances. The problem will be the effect on the structure of capital, which is not “a homogeneous fund that reproduces itself” but an intertemporal structure in dynamic equilibrium and constant change.
Mises summed up the cycle by explaining that in the absence of an increase in intermediate products and without the possibility of extending the average period of production, an interest rate corresponding to a longer average period of production is established, “the fall in the interest rate weakens the motives for saving, slowing down the rate of capital accumulation” so that means of subsistence tend to be consumed before the capital goods used in the expansion are transformed into consumer goods, the reduction of available consumer goods raises their price while production goods fall.
And what made production goods rise more than consumer goods will be reversed by making consumer goods rise, and production goods fall relatively, bringing the interest rate back to the natural rate.
The counter-movement is reinforced in that the reduction of the objective exchange value of money pushes the interest rate above the level that would be required if there was no change in the objective exchange value of money. And he concludes that because the banks, in their monetary policies, cannot reduce continuously the interest rate and put in circulation new fiduciary means, at that time because of the metallic limit.
Yey, also – Mises already warned that the metallic limit would be abandoned – because if it were institutionally possible an avalanche of fiduciary means would finally originate a “situation of panic impossible to contain.” Thus, the old relationship between prices of production and consumer goods will not be restored because the distortion will have caused a redistribution of property.
And it will not be feasible to move all the capital from those uses where it no longer produces profit to others that do, so that some of the capital will have to be stopped, or misused in a barely economic activity. The underlying problem of the harmful effects of fiscal disorder and its monetary financing is that “some economic goods that could have satisfied more important needs have been used for others of lesser importance” and only “to the extent that the error suffered can be rectified by directing resources to better use, can the loss be avoided.”
The main works in which Hayek worked on the theory of the Mises cycle were “Prices and Production”, “The Monetary Theory and the Economic Cycle”, and “The Pure Theory of Capital.” And it is interesting that he developed them parallel to his controversy with Keynes and his Cambridge followers on one hand. And on the other responding to the monetarists who tried a mechanical version of the quantitative theory by adopting the theory of capital that of J.B. Clark and F.H. Knight. That of the circular flow model of income.
The fact that the dominant paradigm in the faculties of economics after the Second World War was a synthesis of this placed the Austrian school in a bad position in the academic world, at least until the second half of the 1970s, when the neo-Keynesian synthesis -also called neoclassical synthesis- came up against unexpected stagflation, Hayek is awarded the Nobel Prize in Economics for “his pioneering work in the theory of money and economic fluctuations and for his penetrating analysis of the interdependence of economic, social, and institutional phenomena.”
The truth is that the present price of money is its purchasing power, and when it falls, agents will eventually adjust their time preference to the new subjective value they will give in their preference scales to present money, and although they will modify their subjective valuation of future money, they will not maintain exactly the previous proportion between one and the other. They will vary their time preference in favor of present money because they will require greater amounts to face equivalent expenses. And because they will tend not to save on trust money that has lost value.
Eventually, interest rates will rise to adjust to future inflation expectations, but with a significant component of uncertainty, savings will weaken more and more, while the real savings medium will move from money to other goods always -which will imply a relative increase in consumption- and sometimes to other currencies.
Generally, people would tend to react to the loss of present value of money in ways that would cause a shift towards a higher intersubjective time preference rate, even if they did not anticipate more future inflation. And that is the underlying economic force behind the rise in the natural rate as a product of the fall in the money rate. And that eventually makes the artificially low money rate unsustainable.
Nothing is different today, except that the political, geopolitical, and ideological circumstances are the worst possible. As always, the cost of fiscal and monetary irresponsibility will fall fatally on one side to those who have less and on the other to those who produce more.