Economic Theory

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On the Possibility of Hyperdeflation

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Even given the failure of hyperinflation to pass since a variety of pop-Austrian TV finance pundits predicted it since 2008 in the wake of the various quantitative easing programs, the world at large continues to talk of the possibility of hyperinflation in the future. The value and purchasing power of money is a significant topic for the entirety of society — savers, debtors, large and small businesses, workers, welfare recipients, pensioners, etc — so it is no surprise that people fixate upon historical events in which the purchasing power of money has gone to zero. Yet this previously-known and widely talked about phenomenon may not occur in the future for most countries. Instead, a previously unknown phenomenon that I now tentatively coin hyperdeflation may be far more common.

Hyperinflation is an interesting phenomenon. As I have noted in the past, it seems to be predominantly associated with collapses in agriculture, infrastructure and transport, the loss of a war or natural disasters. Faced with dire economic breakdown and spiralling prices and wages (as plentiful paper money chases after increasingly scarce and limited goods) monetary policymakers are forced to print in an attempt to keep a broken economy going. In a functional economy like present day Japan, Britain or America with no mass breakdown of institutions, transport or infrastructure (and thus with with freely available food, energy and resources) printing (or digitally multiplying) money does not lead to huge, soaring inflation. But in an economy already disrupted — like the many countries on this list that experienced hyperinflation — the inflationary impact of new base money just continues to spiral, and all the extra paper dumped into the system is simply abandoned and rejected by the public as its purchasing power gravitates toward zero.

And in the modern world, some countries and places may have become more susceptible to the kinds of economic breakdowns that could lead to hyperinflation given a bad-enough shock. In an increasingly interconnective and trade-dependent world, natural disasters or wars can shut off the supply of important products or components that countries or regions do not and cannot manufacture. That makes this a particularly fragile phase of history, even if it does not seem so given the huge and widespread affluence not just in the West, but also increasingly in the developing world.

Yet beyond this phase of history, stretching out into the long run, the opposite may become true. Society is shaped by its technological capacities — this has been true since the days of the spear, the wheel, the bow, etc — and our technological evolution continues at ever rapider rates. The internet has already provided a channel for mass cultural interconnectivity, and the effective decentralisation of media. I have written at length on the possibility of superabundant decentralised energy from falling solar and alternative energy costs, combined with the possibility of mass decentralised molecular manufacturing. Simply, if every house has an advanced 3-D printer that can transform soil and waste into food, consumer electronics, or tools (etc), and a superabundant energy source from high-efficiency solar panels (or artificial fossil fuels, or even micro-nuclear reactors) then the era of material scarcity is effectively over, and humanity can concentrate its energies on other matters (cultural, religious, philosophical, space colonisation, etc). Now, we are still a while away from a single house having such capacities, but the implications of the beginning of that era will be profound.

My supposition is that the era of superabundance will be characterised by very strong deflation as the supply of goods and energy becomes increasingly superabundant. This trend has already begun in the West, where inflation and interest rates have — in the context of cheap Eastern labour, computerisation and automation — been falling for the last 20 years. Even strong quantitative easing by central banks has not reignited strong inflation. My guess is that unless we experience some huge shock that dramatically shakes the foundations of society — like a megatsunami, or a nuclear war, or a mass pandemic that wipes out half the population — it will be hard for strong inflation to ever return no matter how much money central banks print. Central bankers may be able to keep inflation close to zero with strong activist monetary policy, but even that may be challenging especially as the age of superabundance draws onward.

Of course, in a world of material superabundance, trade and business will not end. While everyone may have a molecular factory in their house that can build anything from a huge library of open-sourced 3-D designs downloadable from the internet, people will still have to design things and create things. Although at some stage the machines may become sentient and creative, this appears to be at least a very, very long way away. So all the 3-D printers, robots and unlimited energy in the world won’t for the foreseeable future invent things, or write a Hamlet or a Breaking Bad, or a Dark Side of the Moon or an Emperor Concerto, leaving humans an important niche as designers, empathisers and imagineers. While with superabundant energy and goods, people will have all the resources necessary to devote themselves to such pursuits, people as they have done throughout history will still choose to co-ordinate and collaborate, so they will still need some currency. Whether this will take the form of state fiat money, or private currencies like Bitcoins, Facebook and Youtube likes, or Whuffies, or a mixture of the above remains to be seen.

Another possibility, of course, is that there will still be scarcities even in the era of superabundance. While every house may be able to manufacture an unlimited quantity of food, household goods and gadgets, some highly-desired technologies and goods like interstellar spacecraft or particle accelerators or exotic matter may remain far beyond the reach of a typical household or community either on technological grounds or on the grounds that they are contraband (it is quite easy to imagine that manufacturing of certain goods — weaponry in particular — may be made illegal by states, who may create increasingly sophisticated and Orwellian surveillance structures to prevent the distribution of illegal materials). These post-superabundance scarcities may form the basis of new widespread media of exchange and units of account, especially if state fiat money hyperdeflates its way to irrelevance.

(And yes — in an age of superabundant energy, gold will in all likelihood lose its scarcity, as with enough energy it is possible to transmute lead into gold in a particle accelerator. This means it is quite possible that gold’s all-time high of $1917 in September 2011 may be the highest dollar-denominated price gold ever trades at).

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Why Savers Should Put Up Or Shut Up

There is an idea popular in certain circles that low interest rate policies are stealing from savers. When the economy went into freefall in 2008, central bank interest rates were lowered to the zero bound. And rates for savers and investors in both government and corporate debt have certainly fallen since then:

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Critics of low interest rate policies actually have the wrong end of the stick. It is not central banks that set interest rates for the market. Central banks set lending rates into the banking system. The interest rates in the market remain a function of the demand for savings. Demand for savings (shown as a percentage of GDP, to show the real level of demand for savings relative to economic activity) has absolutely soared since 2008:

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How can savers expect a positive real return on their savings when the demand for savings has gone so high even in the context of lower interest rates in general? Central bank policy is designed to discourage saving and encourage investment and consumption. That’s the point — but even with interest rates close to zero, the growth in savings has not been stanched. All else being equal, had central banks not cut rates, demand for savings would be even higher. And with higher demand for savings, that would have just depressed interest rates to the levels we see now irrespective of central bank policy.

The great irony here, of course, is that there are still high rates of return for those with capital if they look for it. Payday loans companies continue to charge companies interest rates in the thousands of percent lending to people with poor credit histories or who may have lost their jobs in the context of the bad economy. Access to capital is not universal or even widespread. Real incomes are flat on where they were five years ago, which has led many individuals and families into borrowing to meet their bills. The fact that the financial industry is lending to some at huge interest rates and denying credit to many businesses while simultaneously paying smaller interest rates to savers is not symptomatic of theft from savers — it’s symptomatic of financial industry dysfunction, and a failed transmission mechanism.

For savers, positive real return on capital is not a right, and it should not be an expectation especially in a depressed economy. If businesses aren’t mostly expanding and taking on new workers, where is the positive real return going to come from? If wages aren’t rising, where is the positive real return going to come from? If the economy isn’t growing where is the positive real return going to come from? The answer is that with a pie that isn’t growing, those who get a bigger slice will be dispossessing others. Simply, high real rates of interest in the context of a depressed economy are rents, and demanding them — and especially demanding that the government enforce their existence — is rent seeking. This is ultimately why a low-growth environment is naturally and in the long run unavoidably a low interest rate environment. It is not central bank theft. It is the inevitable outcome of a depressed economy.

Savers looking for a larger rate of return should know damn well what to do — take their money out of low interest savings accounts and out of the failed financial intermediation industry and invest it into quality economic projects that create jobs and growth. This could involve buying the stock or debt of large companies that wish to expand, or it could involve starting your own business, or investing in a startup or a mixture of these things. The easiest way to return to growth — and thus higher interest rates, and higher returns for things like pension funds — is for today’s savers complaining about low interest rates to turn into tomorrow’s investors seeking out and pouring money into quality projects that increase incomes, create jobs and create products that people desire and want to use. Sitting on cash in a bank account in the dysfunctional financial system and whining about a low return is incoherent nonsense.

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Minsky, the Lucas Critique, & the Great Moderation

Last week, I noted that the post-2008 world had provided an astonishingly good test for Milton Friedman’s notion that stabilising M2 growth was an effective antidote for economic depressions. Bernanke stabilised M2 growth, yet the depressive effects such as elevated unemployment, elevated long-term unemployment, and depressed growth still appeared, although not to such a great extent as was experienced in the 1930s. Friedman-style macro-stabilisation may have succeeded in reducing the damage, but in terms of preventing the onset of a depression Friedman’s ideas failed.

Of course, the onset of the post-2008 era was in many ways also a failure of the previous regime, and its so-called Great Moderation. Ben Bernanke in 2004 famously noted that “one of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility”.  Bernanke saw successful monetary policy as a significant reason for this stabilisation:

The historical pattern of changes in the volatilities of output growth and inflation gives some credence to the idea that better monetary policy may have been a major contributor to increased economic stability. As Blanchard and Simon (2001) show, output volatility and inflation volatility have had a strong tendency to move together, both in the United States and other industrial countries. In particular, output volatility in the United States, at a high level in the immediate postwar era, declined significantly between 1955 and 1970, a period in which inflation volatility was low. Both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as I have noted, both fell sharply after about 1984. Economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary policy performed quite poorly, relative to both earlier and later periods (Romer and Romer, 2002). Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well.

Bernanke’s presumptive successor, Janet Yellen explained in 2009 that from a Minskian perspective, this drop in visible volatility was itself symptomatic of underlying troubles beneath the surface:

One of the critical features of Minsky’s world view is that borrowers, lenders, and regulators are lulled into complacency as asset prices rise.It was not so long ago — though it seems like a lifetime — that many of us were trying to figure out why investors were demanding so little compensation for risk. For example, long-term interest rates were well below what appeared consistent with the expected future path of short-term rates. This phenomenon, which ended abruptly in mid-2007, was famously characterized by then-Chairman Greenspan as a “conundrum.” Credit spreads too were razor thin. But for Minsky, this behavior of interest rates and loan pricing might not have been so puzzling. He might have pointed out that such a sense of safety on the part of investors is characteristic of financial booms. The incaution that reigned by the middle of this decade had been fed by roughly twenty years of the so-called “great moderation,” when most industrialized economies experienced steady growth and low and stable inflation.

Minsky’s financial instability hypothesis can be thought of as an instance of the Lucas Critique applied to macro-stabilisation. Lucas’ contribution — earlier stated by Keynes — is that agents alter their behaviour and expectations in response to policy.  By enacting stabilisation policies, policy makers change the expectations and behaviour of economic agents. In the Minskian world, the promise and application of macro-stabilisation policies can lead to economic agents engaging in increasingly risky behaviour. A moderation is calm on the surface — strong growth, low inflation — but turbulent in the ocean deep where economic agents believing the hype of the moderation take risks they would otherwise not. In a Minskian world, these two things are not separate facts but deeply and intimately interconnected. Whichever way monetary policy swings, there will still be a business cycle. Only fiscal policy — direct spending on job creation that is not dependent on market mood swings — can bring down unemployment in such a context while the market recovers its lost panache.

The march of monetarists — following the lead of Scott Sumner — toward nominal GDP targeting, under which the central bank would target a level of nominal GDP, is a symptom of Friedman’s and the Great Moderation’s failure. If stabilising M2 growth had worked, nobody would be calling for stabilising other monetary aggregates like M4 growth, or stabilising the nominal level of economic activity in the economy. Sumner believes by definition, I think, that the policies enacted by Bernanke following 2008 were “too tight”, and that much more was needed.

Of course, what the NGDP targeters seem to believe is that they can have their Great Moderation after all if only they are targeting the right variable. This view is shared by other groups, with varying clinical pathways. Followers of von Mises’ business cycle theory believe that an uninhibited market will not exhibit a business cycle, as they believe that the business cycle is a product of government artificially suppressing interest rates. Minsky’s financial instability hypothesis and its notion that stability is destabilising is a slap in the face to all such moderation hypotheses. The more successful the moderation, the more economic agents will gradually change their behaviour to engage in increasingly risky activities, and the more bubbles will form, eventually destabilising the system once again. Markets are inherently tempestuous.

Or at least that is the theory. It would be nice to see empirical confirmation that the moderation produced by Sumnerian NGDP targeting is just as fragile and breakable as the Great Moderation. Which, of course, requires some monetary regimes somewhere to practice NGDP targeting.

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The “Unemployment Is Voluntary” Myth

Loyd S. Pettegrew and Carol A. Vance of the Ludwig von Mises Institute ask and answer a question:

Why does a large portion of the population choose not to work when there are many jobs available? The answer is simple. If you can receive 2-3 times as much money from unemployment, disability, and/or welfare benefits (subsidized housing, food stamps, free cellphones, etc.) as you can from a temporary or part-time job, and live a life of leisure, why work? In 2011, the U.S. government spent over $800 billion on this “welfare,” exceeding expenditures on Social Security or Medicare.

So, is it true? Is the reason why unemployment is elevated that millions of Americans are choosing not to work because of cushy government welfare provisions?

After all, welfare payments as a percentage of GDP and unemployment have risen in tandem:

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However, in this case it is clear that correlation is not causation. Why?

Well, if labour was truly slacking off then we would expect to see a shortage of labour. But instead we see an elevated level of applicants per job openings:

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This means that there are not enough job openings in the economy even for the number of current jobseekers, let alone the discouraged workers and disabled individuals who are claiming welfare. If the Federal government were to throw them all off welfare, the number of jobseekers per opening — already elevated — would soar. This means that the issue causing unemployment is not individuals dropping out of the labour force, but an economy that isn’t creating jobs very rapidly. So welfare is not acting as a disincentive to work, in this case. It is acting as supplementary income for those who cannot otherwise find an opening in the economy due to factors like job migration and automation reducing the level of labour desired by employers.

Under other conditions, it is possible that welfare payments could act as a disincentive to work. If there were a low number of applicants per opening, then welfare that paid better than the lowest-paid jobs available could be seen as a disincentive to work. But now, with job openings at a very low level? Don’t be ridiculous.

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Paying For Our Past Sins

Michael Kinsley’s argument for immediate austerity is about “paying for our past sins”:

Krugman also is on to something when he talks about paying a price for past sins. I don’t think suffering is good, but I do believe that we have to pay a price for past sins, and the longer we put it off, the higher the price will be. And future sufferers are not necessarily different people than the past and present sinners. That’s too easy. Sure let’s raise taxes on the rich. But that’s not going to solve the problem. The problem is the great, deluded middle class—subsidized by government and coddled by politicians. In other words, they are you and me. If you make less than $250,000 a year, Obama has assured us, you are officially entitled to feel put-upon and resentful. And to be immune from further imposition.

Austerians don’t get off on other people’s suffering. They, for the most part, honestly believe that theirs is the quickest way through the suffering. They may be right or they may be wrong. When Krugman says he’s only worried about “premature” fiscal discipline, it becomes largely a question of emphasis anyway. But the austerians deserve credit: They at least are talking about the spinach, while the Krugmanites are only talking about dessert.

To Kinsley, austerity is the necessary spinach. I don’t really understand this. In the United States a crisis in shadow finance spread into the banking industry leading to a default cascade throughout the financial system, which resulted in a wider crisis throughout the economy, and ever since 2008 even after the banking sector was propped-up, unemployment throughout the wider economy has been rife, economic output has fallen far below its long-term trend line, and bank deposits are soaring as the weak economy has damaged confidence and convinced possessors of money to save and not spend or invest.

So many activities in the boom — from home speculation, to NINJA loans, to subprime securitisation, and ultimately the 40-year cycle of total credit growth that led to the Minsky Moment in 2008 — proved unsustainable. But a huge cost has already been paid for those unsustainable activities in the form of the initial crash, and depressed growth, and unemployment, etc. The structure of production has been irrevocably changed by the bust. But are the people suffering the unemployment, the depressed real wage growth, etc, the people who created the total debt growth? No, of course not. Any connection is arbitrary — the people creating the credit default swaps and structured securitised products (ABS, MBS, etc) and NINJA loans that triggered the banking crises in many cases have kept their jobs and been promoted. Certainly, some bankers like Dick Fuld who were involved in creating the crisis lost their jobs, but while people who had nothing whatever to do with the banking crisis have lost their jobs or worse have never even got a job.

So who does Kinsley want to consume the spinach? The people who take the hit to their purchasing power in an austerity program aren’t the ones who caused the financial crisis. Perhaps financial regulators and central bankers were to some degree responsible, but the overwhelming majority of people dependent on government income had nothing whatever to do with financial regulation. Though certainly one side-effect of the crisis has been falling tax revenues, which has meant bigger deficits. But structural deficits are actually relatively low, and nominal deficits are rapidly falling. And the actual interest rate cost of servicing the deficits are at record lows and with current soaring savings levels, unlikely to start rising anytime soon. So any appearance of a deficit problem is a side-effect of a depressed economy. Ultimately, austerity will reduce the government’s use of resources — capital, and labour. And what is the problem with the economy at the moment? Slack resources in capital and labour to such an extent that interest rates are at record lows and unemployment is very high. Kinsley’s “spinach” has nothing whatever to do with the problem. In the long run, once the economy is at full-employment and businesses are booming, and interest rates have risen some austerity will be helpful, not least to take the edge off the boom. But why now? Immediate austerity is iatrogenic medicine — misidentifying the problem, and prescribing a cure that harms the patient.

In my view a bust after an economic boom may be to some degree be unavoidable as an artefact of human psychology. Ultimately, we should remember that a credit-driven boom isn’t a sign of overproduction of goods and services, or a society living beyond its means. After all, the demand for goods and services really existed, and the capacity for the production and use of goods and services really existed. Humans are excitable animals, prone to strange twinges  of spirit both in mania and depression. The business cycle delivers the dessert and the spinach in recurrent cycles. Actions have consequences, and the actions leading into the slump have had huge consequences. But what about our present sins? Having the government force more spinach onto a society already suffering from massive unemployment of people, resources and capital is a strange and cruel prescription. We have already had our spinach in the crash of 2008 and the following slump. Huge numbers of people are unemployed, or have dropped out of the labour force, or have not had the chance to enter the labour force. That is the spinach. If the economy was a man, spinach would be coming out of his ears. Michael Kinsley and his intellectual cousins want to offset spinach with more spinach. Yet the economy has much the same or higher pre-slump capacity for ice cream, and pizza and milkshakes and marshmallows. In the long run, society will rediscover its taste for economic growth, for income growth, and all the slack resources will be used up to produce things that people actually want and need. Yet that does not help the unemployed who have eaten plateful after plateful of spinach as a consequence of actions for which they were mostly not responsible. What could help the unemployed? Job creation and putting slack resources to use.

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Of Joseph & Keynes

Although Keynes’ conceptual framework for macroeconomics was original, the economic ideas broadly known as Keynesianism — the possibility of unclearing markets, and countercyclical spending — are much older than John Maynard Keynes, and their continued predominating association with him is rather puzzling to me. Indeed, looking at Keynes’ ideas through the lens of his predecessors is illuminating.

According to Genesis in the Old Testament, in ancient Egypt, Joseph son of Jacob warned the Pharaoh that his dreams foretold seven years of abundant harvest to be followed by seven years of poor harvests. Farming in the Nile delta depended on good rainfall in the highlands of central Africa to flood the delta area with water and fertile topsoil. Without good rainfall, Egypt was susceptible to famine.

Joseph told the Pharaoh to store a surplus of grain during the first seven years so that the country would have grain during the drought. During the time of plenty, Joseph ordered the storage of 20 percent of farmers’ output in the Pharaoh’s granaries.

This was a countercyclical fiscal policy millennia before Keynes. If we are to be historically correct, Keynesianism might be better known as Josephianism. And although Joseph’s coat-of-many-colours might arouse the suspicions of certain homophobic critics of Keynes, it is noted that Joseph’s wife bore him two sons.

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Keynes’ notion of disequilibrium was a reaction against an idea that only grew wings roughly 130 before Keynes with the industrial revolution — Say’s Law, the notion that “products are paid for with products”, that “a glut can take place only when there are too many means of production applied to one kind of product and not enough to another” and that subsequently “a rational businessman will never hoard money; he will promptly spend any money he gets “for the value of money is also perishable.”

Say’s Law is empirically false. Under certain conditions — including the present condition —  savings levels can soar uncontrollably even while interest rates languish at zero, and while unemployment is elevated. In fact, Say himself foresaw the possibility of massive involuntary unemployment and like Keynes and Bastiat, advocated public works programs to decrease unemployment. Indeed perhaps Say’s Law — at least in its post-Keynes incarnation — is more reflective of the ideas of Nassau Senior or David Ricardo than Jean-Baptiste Say.

Although the human sphere has always been driven to disequilibrium by the divergency of human plans and imaginations, prior to the industrial revolution — like in the time of Joseph and the Pharaoh — the possibility of involuntary unemployment (and starvation, etc) arising out of flood, robbery, famine, plague, drought, barbarian raids or some other externality was everywhere. The difference between the modern breakdowns in the Great Depression and the Post-2008 Depression and pre-industrial breakdowns of production is that the cause of the former is psychological (investors become grossly fearful of markets, etc, allowing resources to sit idle rather than being reallocated to productive uses) while the cause of the latter is actual material scarcity. But in the worst case the result is the same — needs and wants go unsatisfied and skills and trades stagnate. The outcomes of pre-industrial scarcity can seep into the post-industrial world through the channel of human psychology.

Keynes’ and Joseph’s recommendations on saving in the fat years to spend in the lean ones are ultimately apolitical in nature and apply just as much to the private sector as to the public sector. There is a widely-held conception that spending in the slump and saving in the boom is statist and favours central economic planning. This is not necessarily true. If a stateless society — let’s say, a future moon colony led by radical libertarians — becomes depressed, unemployment rises and resources lie idle, one solution to lift economic activity would be voluntary private infrastructure and capital spending. While Keynes himself rather unfortunately noted that “the theory of aggregated production… can be much easier adapted to the conditions of a totalitarian state”, infrastructure spending of private origin would be just as helpful in a depression in a stateless economy.

Yet Keynes sometimes pushed his arguments too far. Keynes suggested that “digging ditches is preferable to doing nothing” and proclaimed that the dawn of the Second World War meant that “the end of abnormal unemployment is in sight”. But wasting idle resources on unwanted projects like ditches or giant space lasers to repel a nonexistent alien invasion, or actively harmful projects like wars even though it may raise aggregate demand is still wasting resources. If the point of countercyclical policy is to avoid excessive levels of stagnation, it seems self-defeating to take idle resources and spend them on something entirely unwanted and unwarranted. Spending labour and capital on a destructive life-ending and infrastructure-destroying war rather than on useful infrastructural and scientific projects is akin to Pharaoh spending grain in a famine to support a war where just as many Egyptians die fighting as would have died in the averted famine.

So for successful countercyclical policy, I think it is important to emphasise quality projects that people actually want rather than simply emphasising aggregate levels of spending. In  Pharaoh’s Egypt, that was a store of grain…

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Nietzsche, Austrianism, Neoclassicalism & Subjectivism

Corey Robin has an enormous, sprawling treatise at The Nation on the influence that Nietzsche may have had first on marginalist economics (Jevons, Walras, Menger) and second on modern free market economics:

The contributions of Jevons and Menger were multiple, yet each of them took aim at a central postulate of economics shared by everyone from Adam Smith to the socialist left: the notion that labor is a — if not the — source of value. Though adumbrated in the idiom of prices and exchange, the labor theory of value evinced an almost primitive faith in the metaphysical objectivity of the economic sphere — a faith made all the more surprising by the fact that the objectivity of the rest of the social world (politics, religion and morals) had been subject to increasing scrutiny since the Renaissance. Commodities may have come wrapped in the pretty paper of the market, but inside, many believed, were the brute facts of nature: raw materials from the earth and the physical labor that turned those materials into goods. Because those materials were made useful, hence valuable, only by labor, labor was the source of value. That, and the fact that labor could be measured in some way (usually time), lent the world of work a kind of ontological status—and political authority—that had been increasingly denied to the world of courts and kings, lands and lords, parishes and priests. As the rest of the world melted into air, labor was crystallizing as the one true solid.

There are, of course, great parallels between the Nietzschean subjectivism, and the subjectivism of Menger in particular.

Nietzsche:

Whatever has value in our world now does not have value in itself, according to its nature — nature is always value-less, but has been given value at some time, as a present — and it was we who gave and bestowed it.

And Menger:

Value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being.

Robin sees these theories as being anti-Marxist, anti-socialist, and anti-labour-theory-of-value in their origins as well as in their modern implications:

By the time the marginalists came on the scene, the most politically threatening version of the labor theory of value was associated with the left. Though Marx would significantly revise and recast it in his mature writings, the simple notion that labor produces value remained associated with his name—and even more so with that of his competitor Ferdinand Lasalle, about whom Nietzsche read a fair amount—as well as with the larger socialist and trade union movements of which he was a part. That association helped set the stage for the marginalists’ critique.

Admittedly, the relationship between marginalism and anti-socialism is complex. On the one hand, there is little evidence to suggest that the first-generation marginalists had heard of, much less read, Marx, at least not at this early stage of their careers. Much more than the threat of socialism underpinned the emergence of marginalist economics, which was as opposed to traditional defenses of the market as it was to the market’s critics. By the twentieth century, moreover, many marginalists were on the left and used their ideas to help construct the institutions of social democracy; even Walras and Alfred Marshall, another early marginalist, were sympathetic to the claims of the left. And on some readings, the mature Marx shares more with the constructivist thrusts of marginalism than he does with the objectivism of the labor theory of value.

On the other hand, Jevons was a tireless polemicist against trade unions, which he identified as “the best example…of the evils and disasters” attending the democratic age. Jevons saw marginalism as a critical antidote to the labor movement and insisted that its teachings be widely transmitted to the working classes. “To avoid such a disaster,” he argued, “we must diffuse knowledge” to the workers—empowered as they were by the vote and the strike—“and the kind of knowledge required is mainly that comprehended in the science of political economy.”

Menger interrupted his abstract reflections on value to make the point that while it may “appear deplorable to a lover of mankind that possession of capital or a piece of land often provides the owner a higher income…than the income received by a laborer,” the “cause of this is not immoral.” It was “simply that the satisfaction of more important human needs depends upon the services of the given amount of capital or piece of land than upon the services of the laborer.” Any attempt to get around that truth, he warned, “would undoubtedly require a complete transformation of our social order.”

Finally, there is no doubt that the marginalists of the Austrian school, who would later prove so influential on the American right, saw their project as primarily anti-Marxist and anti-socialist. “The most momentous consequence of the theory,” declared Wieser in 1891, “is, I take it, that it is false, with the socialists, to impute to labor alone the entire productive return.”

Whatever the originators and developers of the subjective theory of value — whether we mean Nietzschean cultural value, or Mengerian economic value — thought of the politics of the idea is rather irrelevant to me. The basic idea is correct and explanatory — that is, value is entirely in the eye of the beholder, and price is a function of a negotiation process fuelled by the conceptions of value — and any and all political conclusions are secondary to this fact. There were great political and social implications to the heliocentric model of the solar system — after all, that was just as controversial and politically divisive idea in its origins — but those political and social impllications have no bearing on whether the Earth travels around the Sun or vice versa. The same is true for the subjective theory of value and its ideological and political context.

But with great intellectual upheavals comes great resistance. Many so-called disciples of subjectivism have attempted to resurrect more objective approaches to value. That is, subjectivism’s greatest enemies may not have been advocates of the labour theory of value so much as self-described subjectivists who were repulsed by the supposed nihilism of subjectivism.

The neoclassical descendants of Walras and Jevons like Samuelson developed toybox mathematical models based around unrealistic (or semi-realistic) assumptions — rational preferences, utility maximisation, perfect competition, informationally efficient markets, etc. These act as an framework to objectify and rationalise human behaviour ruled not by static rationality but by fleeting, inconsistent subjectivity.

Equally the Austrian descendants of Menger like Mises and Hayek sought to depict the market as a framework as much for organising human morality — rewarding what they conceived of as good behaviour, and punishing what they conceived of as bad behaviour — as for allocating resources. As Hayek noted:

Until 130 or 150 years ago, everybody in what is now the industrialized part of the Western world grew up acquainted with the rules and necessities of what are called commercial or mercantile morals, because everyone worked in a small enterprise where he was equally concerned with, and exposed to, the conduct of others. Whether as master or servant or member of the family, everybody accepted the unavoidable necessity of having to adapt himself to changes in demand, supply, and prices in the marketplace. A change began to happen in the middle of the last century. Where previously perhaps only the aristocracy and its servants were strangers to the rules of the market, the growth of large organizations in business, commerce, finance, and ultimately in government, increased the number of people who grew up without being taught the morals of the market which had been developed in the course of the preceding 2,000 years.

For probably the first time since classical antiquity, an ever-increasing part of the population of the modern industrial state grew up without learning in childhood that it was indispensable to respond as both producer and consumer to all the unpleasant things which the changing market required. This development coincided with the spreading of a new philosophy, which taught people that they ought not to submit to any principle of morals which could not be rationally justified.

To a Nietzschean — or any subjectivist — notions of good behaviour and bad behaviour are as much in the eye of the beholder as the values of commodities. Indeed, that is their crux — humans act in the human spheres of morality and commerce because humans are value-creating! Living out our subjective desires, painting or judging the world with our subjective morals and ethics, and meeting our subjective goals is not a matter of hedonism, but the inevitable consequence of humanity.

These two groups of prescriptive counter-revolutionaries — the Samuelsonian neoclassicals and their objectifying assumptions, and the Misesian Austrians and their moral absolutism — may have turned back the subjectivist revolution to a great degree, but their victory has not been absolute. Some neoclassical economists like Hal Varian seem to have reversed Samuelsonian optimisation into “doing whatever an agent wants”, which is entirely compatible with a subjectivist conception of value. And some Austrians and Post-Keynesians like Ludwig Lachmann and George Shackle have explored subjective economics deeply, looking at the role of discordant expectations and imaginations as a fuel for disequilibrium.

Most importantly, behavioural economics — which is largely descriptive — seeks to understand economics not from the basis of preordained theory and assumptions, but in terms of how agents and systems actually behave in various situations. Ultimately, through the nonjudgmental study of human action we may finally arrive at an economics that reflects value as it really is, and how it was understood by Nietzsche and Menger — as a product of the minds, eyes and hearts of humans.

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No Investment is an Island

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A Chinese woman from Kunming is attempting to sue the Federal Reserve for debasing the dollar:

A woman in Kunming, Yunnan province, is trying to sue the United States central bank after discovering that the real value of the US$250 she put in an account in 2006 had shrunk by 30 per cent.

She claims it was a result of the Federal Reserve issuing too much money.

Her attorney, her son Li Zhen , called the lawsuit “litigation for the public good” which aimed to stop the Fed from continuing its quantitive easing policy and promote people’s awareness of their rights.

This is a quite bizarre claim. If I buy and hold a currency or instruments denominated in that currency, I try to understand the mechanisms through which the market price (or my subjective valuation) of that asset could increase or decrease. In buying dollars, market participants tacitly accept the actions of the United States government and the Federal Reserve system. They tacitly accept that dollars (and implicitly, dollar-denominated instruments) are freely reproducible in either cotton-linen blend, or as digital currency in accordance with the Federal Reserve’s mandate, which includes a definition of price stability of 2% inflation (reduction in purchasing power as measured by the CPI-U) per year.

This is true with other liquid media, as well as less liquid assets like land, companies and capital goods. With gold and silver, future market prices are dependent on the actions and subjective expectations of gold miners and market participants. How much gold will they bring to the market? How much will they dig up out of the ground? To what extent will future market participants desire to hold and own gold? These are the questions one must implicitly answer in buying or selling gold.

The same is true for seashells, Bitcoin, Yen, Sterling, Euro. The differences are in physical characteristics, and the web of social interactions around them. All currencies and liquid assets are built on social interaction. The future viability of any currency or asset is dependent upon a complex web of social interactions.

Users and holders of Bitcoin today have an extraordinarily precise timetable for future monetary production — with Bitcoin, the great uncertainty lies in whether people will choose to use Bitcoin or not, and whether or not governments will try to outlaw it. For modern state-backed fiat currencies, there are legislatively-defined price stability targets designed to regulate monetary production, although the actions of central bankers and macroeconomists may surprise many holders of the currency. The power of the state also matters; a collapse of a state usually spells doom for any fiat currency it has issued.

When we buy something as a store of purchasing power, we enter into an implicit contract with ourselves to accept the currency risks and counterparty risks associated with it. That is our due diligence. Purchasing dollars and then complaining that the Federal Reserve is debasing them is incoherent. No investment is an island, insulated from risk. It is the same as purchasing gold before Columbus sailed to the Americas and complaining when conquistadors brought back huge new supplies of gold that diluted the money supply. The discovery of huge new gold supplies is part of the risk in holding gold, just as quantitative easing is part of the risk in holding dollars.

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Reinhart & Rogoff’s Scary Red Line

One frustrating fact regarding Reinhart & Rogoff’s controversial paper Growth in a Time of Debt — which incidentally was never peer reviewed, even in spite of its publication in the American Economic Review — is that the arbitrary threshold for diminished growth of “above 90%” seems to have no relation whatever with recent events in the United States.

When the financial crisis happened in 2008, and the United States was plunged into deep recession the public debt was actually moderate — higher than the level that Bush inherited in 2000, but less than the level Bill Clinton inherited in 1992. After the crisis, the deficit soared, but as soon as the deficit rose above Reinhart and Rogoff’s red line real growth actually picked up again.

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This very much suggests that in this case the soaring debt was a reaction to recession. Lowered growth preceded soaring public debt, not vice verse.

This is a result supported by econometric analysis. Arindrajit Dube finds a much stronger association in Reinhart and Rogoff’s data between a high debt-to-GDP ratio and weak growth in the past three years than between a high debt-to-GDP ratio and weak growth in the following three years, strongly implying that America’s experience of weak growth preceding soaring public debt is the norm not the exception:

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Reinhart and Rogoff claim that their empirical study never made any claims about causality, although their 2011 editorial for Bloomberg reads as an exposition for the virtues of austerity:

As public debt in advanced countries reaches levels not seen since the end of World War II, there is considerable debate about the urgency of taming deficits with the aim of stabilizing and ultimately reducing debt as a percentage of gross domestic product.

Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP. Nevertheless, many prominent public intellectuals continue to argue that debt phobia is wildly overblown. Countries such as the U.S., Japan and the U.K. aren’t like Greece, nor does the market treat them as such.

Reinhart and Rogoff’s interpretation, then, is clearly that the debt trajectory itself – as opposed to underlying factors driving the debt trajectory — that is the risk, which is a claim unsupported by their own and other research. But the problem is larger than this.

Other empirical work on debt has focused on a broader range of debt while still following Reinhart and Rogoff in attempting to draw arbitrary danger lines on graphs. Cechetti (2011) attempts to factor in household debt (drawing a danger line at 85% of GDP) and corporate debt (90% of GDP) as well as government debt (85%), implying a cumulative danger line of 260% in total credit market debt:

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Total debt seems to have been a more appropriate metric than public debt, because it was in the danger zone when the crisis hit, and after the crisis hit total debt began gradually deleveraging after forty years of steady rises as a percentage of GDP, implying a deep and mechanistic connection. But there is still a lot of room between the crossing of the red line, and the beginning of the deleveraging phase. The red line itself doesn’t tell us anything about the phenomenon of 2008, or the period preceding 1929, where a similar phenomenon occurred, other than implying in a nonspecific way that the rising debt load was becoming unsustainable.

Drawing an arbitrary line on a graph implies that negative effects associated with excessive debt are a linear phenomenon; cross the line, and bad things are more likely to occur. This is an unsophisticated approach. The bursting of debt bubbles is a nonlinear and dynamic process that occurs when credit dries up, and leverage collapses. This specific effect is not tied to any specific nominal debt level, but instead to an unpredictable mixture of market participants’ expectations about the economy, profit taking, default rates, the actions of the central bank, input costs (e.g. energy), geopolitics, etc.

Steve Keen’s modification of Goodwin’s models may be an important step toward a clearer and more mechanistic understanding of the credit cycle and how an economy can be driven into a Minsky Moment.  One of the keys to modelling Minsky’s notion of a credit-driven euphoria giving way to credit contraction, asset price falls and despair is the notion of credit acceleration, the speed at which growth in credit grows. While total credit growth acceleration is clearly a signal of an impending Minsky Moment and debt deflation, drawing scary red thresholds is a fundamentally fruitless exercise, especially in sole regard to government debt levels which do not appear to drive an economy into a Minsky Moment followed by deleveraging and weakened growth and employment.

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Of Reinhart & Rogoff & the Emperor’s New Clothes

The brutal smashing that Reinhart and Rogoff’s work has taken in the past 24 hours, was inevitable even without the catalogue of serious methodological errors in their paper.

Reinhart and Rogoff’s empirical result posited a clear threshold. Reinhart and Rogoff were clear that  debt-to-GDP ratio above 90% spelled doom for growth. The actual data is far less clear:

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There is some correlation, but that correlation was loose enough to suggest that this was just one factor of many, and it never said anything at all about whether high debt caused low growth, or low growth caused high debt, or whether some exogenous factor was causing both. The real questions are all about causation.

Far from being a magical no-growth threshold, the UK experienced some of its strongest growth at a public debt level above 90% of GDP, suggesting very strongly that there are many other factors in play. In general, I would tend to caution against the use of arbitrary thresholds to establish principles in economics, whether that is the debt level necessary to lower growth, or the leverage level necessary to trigger a bank run, etc. The evidence suggests these almost certainly vary on a case-by-case basis.

Of course, much of the pro-austerity case seems to have been built on Reinhart and Rogoff.

Olli Rehn of the European Commission defended austerity as follows:

[I]t is widely acknowledged, based on serious research, that when public debt levels rise about 90% they tend to have a negative economic dynamism, which translates into low growth for many years.

Paul Ryan defended austerity using the same criteria:

Economists who have studied sovereign debt tell us that letting total debt rise above 90 percent of GDP creates a drag on economic growth and intensifies the risk of a debt-fueled economic crisis.

Timothy Geithner too:

It’s an excellent study, although in some ways what you’ve summarized understates the risks.

Lord Lamont of Lerwick (an adviser to David Cameron) agreed:

[W]e would soon get to a situation in which a debt-to-GDP ratio would be 100%. As economists such as Reinhart and Rogoff have argued, that is the level at which the overall stock of debt becomes dangerous for the long-term growth of an economy. They would argue that that is why Japan has had such a bad time for such a long period. If deficits really solved long-term economic growth, Japan would not have been stranded in the situation in which it has been for such a long time.

Doug Holtz-Eakin, Chairman of the American Action Forum:

The debt hurts the economy already. The canonical work of Carmen Reinhart and Kenneth Rogoff and its successors carry a clear message: countries that have gross government debt in excess of 90% of Gross Domestic Product (GDP) are in the debt danger zone. Entering the zone means slower economic growth.

This all feels very much like a case of the Emperor’s New Clothes. Those shining robes that cloaked the austerian case for austerity now and at-all-costs were based on serious methodological errors — as opposed to more nuanced criteria for fiscal consolidation during the boomtime, when interest rates on government debt exceed the unemployment rate. All those serious people who praised Reinhart and Rogoff’s seriousness clearly didn’t read it very well, or study the underlying data. Much more like they formed an opinion on the necessity of austerity now, and looked around for whatever evidence they could find for their preconception, whether Reinhart and Rogoff, or Alessina and Ardagna.

The fact that Reinhart and Rogoff did not, and are still not prepared to issue some clarification to their study to prevent its abuse by austerity-obsessed policymakers is sad given the copious evidence that austerity under present conditions is self-defeating. The fact that their response has so far consisted of defending their very weak conclusions — in full knowledge of the political implications of their work, and how it has been used to justify harsh austerity in very slack economic conditions — is very sad indeed.