Archive for April, 2013

They Come not to Praise Market Monetarism, but to Bury It

For some reason – maybe he is still annoyed with Scott Sumner – Paul Krugman decided to channel a post by Mike Konczal purporting to show that Market Monetarism has been refuted by the preliminary first quarter GDP numbers showing NGDP increasing at a 3.7% rate and real GDP increasing at a 2.5% rate in Q1. To Konczal and Krugman (hereinafter K&K) this shows that fiscal policy, not monetary policy, is what matters most for macroeconomic performance. Why is that? Because the Fed, since embarking on its latest splurge of bond purchasing last September, has failed to stimulate economic activity in the face of the increasingly contractionary stance of fiscal policy since them (the fiscal 2013 budget deficit recently being projected to be $775 billion, a mere 4.8% of GDP).

So can we get this straight? GDP is now rising at about the same rate it has been rising since the start of the “recovery” from the 2007-09 downturn. Since September monetary policy has become easier and fiscal policy tighter. And that proves what? Sorry, I still don’t get it. But then again, I was always a little slow on the uptake.

Marcus Nunes, the Economist, Scott Sumner, and David Beckworth all weigh in on the not very devastating K&K onslaught. (Also see this post by Evan Soltas written before the fact.) But let me try to cool things down a bit.

If we posit that we are still in something akin to a zero-lower-bound situation, there are perfectly respectable theoretical grounds on which to recommend both fiscal and monetary stimulus. It is true that monetary policy, in principle, could stimulate a recovery even without fiscal stimulus — and even in the face of fiscal contraction — but for monetary policy to be able to be that effective, it would have to operate through the expectations channel, raising price-level expectations sufficiently to induce private spending. However, for good or ill, monetary policy is not aiming at more than a marginal change in inflation expectations. In that kind of policy environment, the potential effect of monetary policy is sharply constrained. Hence, the monetary theoretical case for fiscal stimulus. This is classic Hawtreyan credit deadlock (see here and here).

If monetary policy can’t do all the work by itself, then the question is whether fiscal policy can help. In principle it could if the Fed is willing to monetize the added debt generated by the fiscal stimulus. But there’s the rub. If the Fed has to monetize the added debt created by the fiscal stimulus — which, for argument’s sake, let us assume is more stimulative than equivalent monetary expansion without the fiscal stimulus — what are we supposed to assume will happen to inflation and inflation expectations?

Here is the internal contradiction – the Sumner critique, if you will – implicit in the Keynesian fiscal-policy prescription. Can fiscal policy work without increasing the rate of inflation or inflation expectations? If monetary policy alone cannot work, because it cannot break through the inflation targeting regime that traps us at the 2 percent inflation ceiling, how is fiscal policy supposed to work its way around the 2% inflation ceiling, except by absolving monetary policy of the obligation to keep inflation at or below the ceiling? But if we can allow the ceiling to be pierced by fiscal policy, why can’t we allow it to be pierced by monetary policy?

Perhaps K&K can explain that one to us.

Mrs. Merkel Lives in a World of Her Own

I woke up today to read the following on the front page of the Financial Times (“Merkel highlights Eurozone divisions with observations on interest rates”).

Angela Merkel underlined the gulf at the heart of the eurozone when she waded into interest-rate policy, arguing that, taken in isolation, Germany would need higher rates, in contrast to southern states that are crying out for looser monetary policy.

The German chancellor’s highly unusual intervention on Thursday, a week before many economists expect the independent European Central Bank to cut its main interest rate, highlights how the economies of the prosperous north and austerity-hit south remain far apart.

What could Mrs. Merkel possibly have meant by this remark? Presumably she means that inflation in Germany is higher than she would like it to be, so that her preference would be that the ECB raise its lending rate, thereby tightening monetary policy for the entire Eurozone in order to bring down the German rate of inflation (which is now less than 2 percent under every measure). The question is why did she bother to say this? My guess is that she is trying to make herself look as if she is being solicitous of the poor unfortunates who constitute the rest of the Eurozone, those now suffering from a widening and deepening recession.

Her message is: “Look, if I had my way, I would raise interest rates, forcing an even deeper recession and even more pain on the rest of you moochers. But, tender-hearted softy that I am, I am not going to do that. I will settle for keeping the ECB lending rate at its current level, or maybe, if you bow and scrape enough, I might, just might, allow the ECB to cut the rate by a quarter of a percent. But don’t think for even a minute that I am going to allow the ECB to follow the Fed and the Bank of Japan in adopting any kind of radical, inflationist quantitative easing.”

So the current German rate of inflation of 1-2% is too high for Mrs. Merkel. The adjustment in relative prices between Germany and the rest of Eurozone requires that prices and wages in the rest of the Eurozone fall relative to prices and wages in Germany. Mrs. Merkel says that she will not allow inflation in Germany to go above 1-2%. What does that say about what must happen to prices and wages in the rest of the Eurozone? Do the math. So if Mrs. Merkel has her way — and she clearly speaks with what Mark Twain once called “the calm confidence of a Christian holding four aces” – things will continue to get worse, probably a lot worse, in the Eurozone before they get any better. Get used to it.

Liquidity Trap or Credit Deadlock

In earlier posts in my series about Hawtrey and Keynes, I’ve mentioned the close connection between Hawtrey’s concept of a “credit deadlock” and the better-known Keynesian concept of a “liquidity trap,” a term actually coined by J. R. Hicks in his classic paper summarizing the Keynesian system by way of the IS-LM model. As I’ve previously noted, the two concepts, though similar, are not identical, a characteristic of much of their work on money and business cycles. Their ideas, often very similar, almost always differ in some important way, often leading to sharply different policy implications. Keynes recognized the similarities in their thinking, acknowledging his intellectual debt to Hawtrey several times, but, on occasion, Keynes could not contain his frustration and exasperation with what he felt was Hawtrey’s obstinate refusal to see what he was driving at.

In this post, commenter GDF asked me about the credit deadlock and the liquidity trap:

Would you mind explaining your thoughts apropos of differences between Hawtrey’s credit deadlock theory and Keynes’ liquidity trap. It seems to me that modern liquidity trapists like Krugman, Woodford etc. have more in common with Hawtrey than Keynes in the sense that they deal with low money demand elasticity w.r.t. the short rate rather than high money demand elasticity w.r.t. the long rate.

To which I answered:

My view is that credit deadlock refers to a situation of extreme entrepreneurial pessimism, which I would associate with negative real rates of interest. Keynes’s liquidity trap occurs at positive real rates of interest (not the zero lower bound) because bear bond speculators will not allow the long-term rate to fall below some lower threshold because of the risk of suffering a capital loss on long-term bonds once the interest rate rises. Hawtrey did not think much of this argument.

Subsequently in this post, commenter Rob Rawlings suggested that I write about the credit deadlock and provided a link to a draft of a paper by Roger Sandilands, “Hawtreyan ‘Credit Deadlock’ or Keynesian ‘Liquidity Trap’? Lessons for Japan from the Great Depression” (eventually published as the final chapter in the volume David Laidler’s Contributions to Economics, edited by Robert Leeson, an outstanding collection of papers celebrating one of the greatest economists of our time). In our recent exchange of emails about Hawtrey, Laidler also drew my attention to Sandilands’s paper.

Sandilands’s paper covers an extremely wide range of topics in both the history of economics (mainly about Hawtrey and especially the largely forgotten Laughlin Currie), the history of the Great Depression, and the chronic Japanese deflation and slowdown since the early 1990s. But for this post, the relevant point from Sandilands’s paper is the lengthy quotation with which he concludes from Laidler’s paper, “Woodford and Wicksell on Interest and Prices: The Place of the Pure Credit Economy in the Theory of Monetary Policy.”

To begin with, a “liquidity trap” is a state of affairs in which the demnd for money becomes perfectly elastic with respect to a long rate of interest at some low positive level of the latter. Until the policy of “quantitative easing” was begun in 2001, the ratio of the Japanese money stock to national income, whether money was measured by the base, M1, or any broader aggregate, rose slowly at best, and it was short, not long, rates of interest that were essentially zero. Given these facts, it is hard to see what the empirical basis for the diagnosis of a liquidity trap could have been. On the other hand, and again before 2001, the empirical evidence gave no reason to reject the hypothesis that a quite separate and distinct phenomenon was at work, namely a Hawtreyan “credit deadlock”. Here the problem is not a high elasticity of the economy’s demand for money with respect to the long rate of interest, but a low elasticity of its demand for bank credit with respect to the short rate, which inhibits the borrowing that is a necessary prerequisite for money creation. The solution to a credit deadlock, as Hawtrey pointed out, is vigorous open market operations to bring about increases in the monetary base, and therefore the supply of chequable deposits, that mere manipulation of short term interest rates is usually sufficient to accomplish in less depressed times.

Now the conditions for a liquidity trap might indeed have existed in Japan in the 1990s. Until the credit deadlock affecting its monetary system was broken by quantitative easing in 2001 . . . it was impossible to know this. As it has happened, however, the subsequent vigorous up-turn of the Japanese economy that began in 2002 and is still proceeding is beginning to suggest that there was no liquidity trap at work in that economy. If further evidence bears out this conclusion, a serious policy error was made in the 1990s, and that error was based on a theory of monetary policy that treats the short interest rate as the central bank’s only tool, and characterizes the transmission mechanism as working solely through the influence of interest rates on aggregate demand.

That theory provided no means for Japanese policy makers to distinguish between a liquidity trap, which is a possible feature of the demand for money function, and a credit deadlock which is a characteristic of the money supply process, or for them to entertain the possibility that variations in the money supply might affect aggregate demand by channels over and above any effect on market rates of interest. It was therefore a dangerously defective guide to the conduct of monetary policy in Japan, as it is in any depressed economy.

Laidler is making two important points in this quotation. First, he is distinguishing, a bit more fully than I did in my reply above to GDF, between a credit deadlock and a liquidity trap. The liquidity trap is a property of the demand for money, premised on an empirical hypothesis of Keynes about the existence of bear speculators (afraid of taking capital losses once the long-term rate rises to its normal level) willing to hold unlimited amounts of money rather than long-term bonds, once long-term rates approach some low, but positive, level. But under Keynes’s analysis, there would be no reason why the banking system would not supply the amount of money demanded by bear speculators. In Hawtrey’s credit deadlock, however, the problem is not that the demand to hold money becomes perfectly elastic when the long-term rate reaches some low level, but that, because entrepreneurial expectations are so pessimistic, banks cannot find borrowers to lend to, even if short-term rates fall to zero. Keynes and Hawtrey were positing different causal mechanisms, Keynes focusing on the demand to hold money, Hawtrey on the supply of bank money. (I would note parenthetically that Laidler is leaving out an important distinction between the zero rate at which the central bank is lending to banks and the positive rate — sufficient to cover intermediation costs – at which banks will lend to their customers. The lack of borrowing at the zero lower bound is at least partly a reflection of a disintermediation process that occurs when there is insufficient loan demand to make intermediation by commercial banks profitable.)

Laidler’s second point is an empirical judgment about the Japanese experience in the 1990s and early 2000s. He argues that the relative success of quantitative easing in Japan in the early 2000s shows that Japan was suffering not from a liquidity trap, but from a credit deadlock. That quantitative easing succeeded in Japan after years of stagnation and slow monetary growth suggests to Laidler that the problem in the 1990s was not a liquidity trap, but a credit deadlock. If there was a liquidity trap, why did the unlimited demand to hold cash on the part of bear speculators not elicit a huge increase in the Japanese money supply? In fact, the Japanese money supply increased only modestly in the 1990s. The Japanese recovery in the early 200s coincided with a rapid increase in the money supply in response to open-market purchases by the Bank of Japan.  Quantitative easing worked not through a reduction of interest rates, but through the portfolio effects of increasing the quantity of cash balances in the economy, causing an increase in spending as a way of reducing unwanted cash balances.

How, then, on Laidler’s account, can we explain the feebleness of the US recovery from the 2007-09 downturn, notwithstanding the massive increase in the US monetary base? One possible answer, of course, is that the stimulative effects of increasing the monetary base have been sterilized by the Fed’s policy of paying interest on reserves. The other answer is that increasing the monetary base in a state of credit deadlock can stimulate a recovery only by changing expectations. However, long-term expectations, as reflected in the long-term real interest rates implicit in TIPS spreads, seem to have become more pessimistic since quantitative easing began in 2009. In this context, a passage, quoted by Sandilands, from the 1950 edition of Hawtrey’s Currency and Credit seems highly relevant.

If the banks fail to stimulate short-term borrowing, they can create credit by themselves buying securities in the investment market. The market will seek to use the resources thus placed in it, and it will become more favourable to new flotations and sales of securities. But even so and expansion of the flow of money is not ensured. If the money created is to move and to swell the consumers’ income, the favourable market must evoke additional capital outlay. That is likely to take time and conceivably capital outlay may fail to respond. A deficiency of demand for consumable goods reacts on capital outlay, for when the existing capacity of industries is underemployed, there is little demand for capital outlay to extend capacity. . .

The deadlock then is complete, and, unless it is to continue unbroken till some fortuitous circumstance restarts activity, recourse must be had to directly inflationary expedients, such as government expenditures far in excess of revenue, or a deliberate depreciation of the foreign exchange value of the money unit.

The Golden Constant My Eye

John Tamny, whose economic commentary I usually take with multiple grains of salt, writes an op-ed about the price of gold in today’s Wall Street Journal, a publication where the probability of reading nonsense is dangerously high. Amazingly, Tamny writes that the falling price of gold is a good sign for the US economy. “The recent decline in the price of gold, ” Tamny informs us, “is cause for cautious optimism.” What’s this? A sign that creeping sanity is infiltrating the editorial page of the Wall Street Journal? Is the Age of Enlightenment perhaps dawning in America?

Um, not so fast. After all, we are talking about the Wall Street Journal editorial page. Yep, it turns out that Tamny is indeed up to his old tricks again.

The precious metal has long been referred to as “the golden constant” for its steady value. An example is the skyrocketing price of gold in the 1970s, which didn’t so much signal a spike in gold’s value as it showed the decline of the dollar in which it was priced. If gold’s constancy as a measure of value is doubted, consider oil: In 1971 an ounce of gold at $35 bought 15 barrels, in 1981 an ounce of gold at $480 similarly bought 15 barrels, and today an ounce once again buys a shade above 15.

OMG! The golden constant! Gold was selling for about $35 an ounce in 1970 rose to nearly $900 an ounce in 1980, fell to about $250 an ounce in about 2001, rose back up to almost $1900 in 2011 and is now below $1400, and Mr. Tamny thinks that the value of gold is constant. Give me a break. Evidently, Mr. Tamny attaches deep significance to the fact that the value of gold relative to the value of a barrel of oil was roughly 15 barrels of oil per ounce in 1971, and again in 1981, and now, once again, is at roughly 15 barrels per ounce, though he neglects to inform us whether the significance is economic or mystical.

So I thought that I would test the constancy of this so-called relationship by computing the implied exchange rate between oil and gold since April 1968 when the gold price series maintained by the Federal Reserve Bank of St. Louis begins. The chart below, derived from the St. Louis Fed, plots the monthly average of the number of barrels of oil per ounce of gold from April 1968 (when it was a bit over 12) through March 2013 (when it was about 17). But as the graph makes clear the relative price  of gold to oil has been fluctuating wildly over the past 45 years, hitting a low of 6.6 barrels of oil per ounce of gold in June 2008, and a high of 33.8 barrels of oil per ounce of gold in July 1973. And this graph is based on monthly averages; plotting the daily fluctuations would show an even greater amplitude.

barrels_of_oil_per_ounce_of_goldDo Mr. Tamny and his buddies at the Wall Street Journal really expect people to buy this nonsense? This is what happens to your brain when you are obsessed with gold. If you think that the US and the world economies have been on a wild ride these past five years, imagine what it would have been like if the US or the world price level had been fluctuating as the relative price of gold in terms of oil has been fluctuating over the same time period. And don’t even think about what would have happened over the past 45 years under Mr. Tamny’s ideal, constant, gold-based monetary standard.

Let’s get this straight. The value of gold is entirely determined by speculation. The current value of gold has no relationship — none — to the value of the miniscule current services gold now provides. It is totally dependent on the obviously not very well-informed expectations of people like Mr. Tamny.

Gold indeed had a relatively stable value over long periods of time when there was a gold standard, but that was largely due to fortuitous circumstances, not the least of which was the behavior of national central banks that would accumulate gold or give up gold as needed to prevent the value of gold from fluctuating as wildly as it otherwise would have. When, as a result of the First World War, gold was largely demonetized, prices were no longer tied to gold. Then, in the 1920s, when the world tried to restore the gold standard, it was beyond the capacity of the world’s central banks to recreate the gold standard in such a way that their actions smoothed the inevitable fluctuations in the value of gold. Instead, their actions amplified fluctuations in the value of the gold, and the result was the greatest economic catastrophe the world had seen since the Black Death. To suggest another restoration of the gold standard in the face of such an experience is sheer lunacy. But, as members of at least one of our political parties can inform you, just in case you have been asleep for the past decade or so, the lunatic fringe can sometimes transform itself . . . into the lunatic mainstream.

David Laidler on Hawtrey and the Treasury View

My recent post on Hawtrey and the Treasury View occasioned an exchange of emails with David Laidler about Hawtrey, the Treasury View. and the gold standard. As usual, David made some important points that I thought would be worth sharing. I will try to come back to some of his points in future posts, but for now I will just refer to his comments about Hawtrey and the Treasury View.

David drew my attention to his own discussion of Hawtrey and the Treasury View in his excellent book Fabricating the Keynesian Revolution (especially pp. 112-28). Here are some excerpts.

It is well known that Hawtrey was a firm advocate of using the central bank’s discount rate – bank rate, as it is called in British terminology – as the principal instrument of monetary policy, and this might at first sight seem to place him in the tradition of Walter Bagehot. However, Hawtrey’s conception of the appropriate target for policy was very different from Bagehot’s, and he was well aware of the this difference. Bagehot had regarded the maintenance of gold convertibility as the sine qua non of monetary policy, and as Hawtrey told reader of his Art of Central Banking, “a central bank working the gold standard must rectify an outflow of gold by a restriction of credit and an inflow of gold by a relaxation of credit. Under Hawtrey’s preferred scheme, on the other hand,

substantially the plan embodied in the currency resolution adopted at the Genoa Conference of 1922, . . . the contral banks of the world [would[ regulated credit with a view to preventing undue fluctuations in the purchasing power of gold.

More generally he saw the task of central banking as being to mitigate that inherent instability of credit which was the driving force of economic fluctuations, by ensuring, as far as possible, that cumulative expansions and contractions of bank deposits were eliminated, or, failing that, when faced by depression, to bring about whatever degree of monetary expansion might be required to restore economic activity to a satisfactory level. (pp. 122-23)

Laidler links Hawtrey’s position about the efficacy of central bank policy in moderating economic fluctuations to Hawtrey’s 1925 paper on public-works spending and employment, the classic statement of the Treasury View.

Unlike the majority of his English . . . contemporaries, Hawtrey thus had few doubts about the ultimate powers of conventional monetary policy to stimulate the economy, even in the most depressed circumstances. In parallel with that belief . . . he was skeptical about the powers of government-expenditure programs to have any aggregate effects on income and employment, except to the extent that they were financed by money creation. Hawtrey was, in fact, the originator of the particular version of “the Treasury view” of those matters that Hicks . . . characterized in terms of a vertical-LM-curve version of the IS-LM framework.

Hawtrey had presented at least the bare bones of that doctrine in Good and Bad Trade (1913), but his definitive exposition is to be found in his 1925 Economica paper. . . . [T]hat exposition was cast in terms of a system in which, given the levels of money wages and prices, the levels of output and employment were determined by the aggregate rate of low of expenditure on public works can be shown to imply an increase in the overall level of effective demand, the consequences must be an equal reduction in the expenditure of some other sector. . . .

That argument by Hawtrey deserves more respect than it is usually given. His conclusions do indeed follow from the money-growth-driven income-expenditure system with which he analysed the cycle. They follow from an IS-LM model when the economy is operating where the interest sensitivity of the demand for money in negligible, so that what Hicks would later call “the classical theory” is relevant. If, with the benefit of hindsight, Hawtrey might be convicted of over-generalizing from a special case, his analysis nevertheless made a significant contribution in demonstrating the dangers inherent in Pigou’s practice of going “behind the distorting veil of money” in order to deal with such matters. Hawtrey’s view, that the influence of public-works expenditures on the economy’s overall rate of flow of money expenditures was crucial to their effects on employment was surely valid. (pp.125-26)

Laidler then observes that no one else writing at the time had identified the interest-sensitivity of the demand for money as the relevant factor in judging whether public-works expenditure could increase employment.

It is true that the idea of a systematic interest sensitivity of the demand for money had been worked out by Lavington in the early 1920s, but it is also true that none of Hawtrey’s critics . . . saw its critical relevance to this matter during that decade and into the next. Indeed, Hawtrey himself came as close as any of them did before 1936 to developing a more general, not to say correct, argument about thte influence of the monetary system on the efficacy of public-works expenditure. . . . And he argued that once an expansion got under way, increased velocity would indeed accompany it. However, and crucially, he also insisted that “if no expansion of credit at all is allowed, the conditions which produce increased rapidity of circulation cannot begin to develop.”

Hindsight, illuminated by an IS-LM diagram with an upward-sloping LM curve, shows that the last step of his argument was erroneous, but Hawtrey was not alone in holding such a position. The fact is that in the 1920s and early 1930s, many advocates of public-works expenditures were careful to note that their success would be contingent upon their being accommodated by appropriate monetary measures. For example, when Richard Kahn addressed that issue in his classic article on the employment multiplier, he argued as follows:

It is, however, important to realize that the intelligent co-operation of the banking system is being taken for granted. . . . If the increased circulation of notes and the increased demand for working capital that may result from increased employment are made the occasion for a restriction of credit, then any attempt to increase employment . . . may be rendered nugatory. (pp. 126-27)

Thus, Laidler shows that Hawtrey’s position on the conditions in which public-works spending could increase employment was practically indistinguishable from Richard Kahn’s position on the same question in 1931. And I would emphasize once again that, inasmuch as Hawtrey’s 1925 position was taken when the Bank of England policy was setting its lending rate at the historically high level of 5% to encourage an inflow of gold and allow England to restore the gold standard at the prewar parity, Hawtrey was correct, notwithstanding any tendency of public-works spending to increase velocity, to dismiss public-works spending as a remedy for unemployment as long as bank rate was not reduced.

The Gold Bubble Is Bursting: Who’s To Blame?

The New York Times finally caught on today that the gold bubble is bursting, months after I had alerted the blogosphere. But even though I haven’t received much credit for scooping the Times, I am still happy to see that word that the bubble has burst is spreading.

Gold, pride of Croesus and store of wealth since time immemorial, has turned out to be a very bad investment of late. A mere two years after its price raced to a nominal high, gold is sinking — fast. Its price has fallen 17 percent since late 2011. Wednesday was another bad day for gold: the price of bullion dropped $28 to $1,558 an ounce.

It is a remarkable turnabout for an investment that many have long regarded as one of the safest of all. The decline has been so swift that some Wall Street analysts are declaring the end of a golden age of gold. The stakes are high: the last time the metal went through a patch like this, in the 1980s, its price took 30 years to recover.

What went wrong? The answer, in part, lies in what went right. Analysts say gold is losing its allure after an astonishing 650 percent rally from August 1999 to August 2011. Fast-money hedge fund managers and ordinary savers alike flocked to gold, that haven of havens, when the world economy teetered on the brink in 2009. Now, the worst of the Great Recession has passed. Things are looking up for the economy and, as a result, down for gold. On top of that, concern that the loose monetary policy at Federal Reserve might set off inflation — a prospect that drove investors to gold — have so far proved to be unfounded.

And so Wall Street is growing increasingly bearish on gold, an investment that banks and others had deftly marketed to the masses only a few years ago. On Wednesday, Goldman Sachs became the latest big bank to predict further declines, forecasting that the price of gold would sink to $1,390 within a year, down 11 percent from where it traded on Wednesday. Société Générale of France last week issued a report titled, “The End of the Gold Era,” which said the price should fall to $1,375 by the end of the year and could keep falling for years.

Granted, gold has gone through booms and busts before, including at least two from its peak in 1980, when it traded at $835, to its high in 2011. And anyone who bought gold in 1999 and held on has done far better than the average stock market investor. Even after the recent decline, gold is still up 515 percent.

But for a generation of investors, the golden decade created the illusion that the metal would keep rising forever. The financial industry seized on such hopes to market a growing range of gold investments, making the current downturn in gold felt more widely than previous ones. That triumph of marketing gold was apparent in an April 2011 poll by Gallup, which found that 34 percent of Americans thought that gold was the best long-term investment, more than another other investment category, including real estate and mutual funds.

It is hard to know just how much money ordinary Americans plowed into gold, given the array of investment vehicles, including government-minted coins, publicly traded commodity funds, mining company stocks and physical bullion. But $5 billion that flowed into gold-focused mutual funds in 2009 and 2010, according to Morningstar, helped the funds reach a peak value of $26.3 billion. Since hitting a peak in April 2011, those funds have lost half of their value.

“Gold is very much a psychological market,” said William O’Neill, a co-founder of the research firm Logic Advisors, which told its investors to get out of all gold positions in December after recommending the investment for years. “Unless there is some unforeseen development, I think the market is going lower.”

The smart money is getting out fast.

Investment professionals, who have focused many of their bets on gold exchange-traded funds, or E.T.F.’s, have been faster than retail investors to catch wind of gold’s changing fortune. The outflow at the most popular E.T.F., the SPDR Gold Shares, was the biggest of any E.T.F. in the first quarter of this year as hedge funds and traders pulled out $6.6 billion, according to the data firm IndexUniverse. Two prominent hedge fund managers who had taken big positions in gold E.T.F.’s, George Soros and Louis M. Bacon, sold in the last quarter of 2012, according to recent regulatory filings.

“Gold was destroyed as a safe haven, proved to be unsafe,” Mr. Soros said in an interview last week with The South China Morning Post of Hong Kong. “Because of the disappointment, most people are reducing their holdings of gold.”

And if you happen to think that the nearly $400 an ounce drop in the price of gold since it peaked in 2011 is no big deal, have a look at these two graphs. The first is the Case-Shiller house price index from 1987 to 2008. The second is the price of gold from 1985 to 2013.



Of course now that it is semi-official that the gold bubble has burst, isn’t it time to start looking for someone to blame it on? I mean we blamed Greenspan and Bernanke for the housing bubble, right. There must be someone (or two, or three) to blame for the gold bubble.

Juliet Lapidos, on the editorial page editor’s blog of  the Times, points an accusing finger at Ron Paul, dredging up quotes like this from the sagacious Congressman.

As the fiat money pyramid crumbles, gold retains its luster.  Rather than being the barbarous relic Keynesians have tried to lead us to believe it is, gold is, as the Bundesbank president put it, ‘a timeless classic.’  The defamation of gold wrought by central banks and governments is because gold exposes the devaluation of fiat currencies and the flawed policies of government.  Governments hate gold because the people cannot be fooled by it.

Fooled by gold? No way.

But the honorable Mr. Paul is surely not alone in beating the drums for gold. If he were still alive, it would have been nice to question Murray Rothbard about his role in feeding gold mania. But we still have Rothbard’s partner Lew Rockwell with us, maybe we should ask him for his take on the gold bubble. Indeed, inquiring minds want to know: what is the Austrian explanation for the gold bubble?

Hawtrey and the “Treasury View”

Mention the name Ralph Hawtrey to most economists, even, I daresay to most monetary economists, and you are unlikely to get much more than a blank stare. Some might recognize the name because of it is associated with Keynes, but few are likely to be able to cite any particular achievement or contribution for which he is remembered or worth remembering. Actually, your best chance of eliciting a response about Hawtrey might be to pose your query to an acolyte of Austrian Business Cycle theory, for whom Hawtrey frequently serves as a foil, because of his belief that central banks ought to implement a policy of price-level (actually wage-level) stabilization to dampen the business cycle, Murray Rothbard having described him as “one of the evil genius of the 1920s” (right up there, no doubt, with the likes of Lenin, Trotsky, Stalin and Mussolini). But if, despite the odds, you found someone who knew something about Hawtrey, there’s a good chance that it would be for his articulation of what has come to be known as the “Treasury View.”

The Treasury View was a position articulated in 1929 by Winston Churchill, then Chancellor of the Exchequer in the Conservative government headed by Stanley Baldwin, in a speech to the House of Commons opposing proposals by Lloyd George and the Liberals, supported notably by Keynes, to increase government spending on public-works projects as a way of re-employing the unemployed. Churchill invoked the “orthodox Treasury View” that spending on public works would simply divert an equal amount of private spending on other investment projects or consumption. Spending on public-works projects was justified if and only if the rate of return over cost from those projects was judged to be greater than the rate of return over cost from alternative private spending; public works spending could not be justified as a means by which to put the unemployed back to work. The theoretical basis for this position was an article published by Hawtrey in 1925 “Public Expenditure and the Demand for Labour.”

Exactly how Hawtrey’s position first articulated in a professional economics journal four years earlier became the orthodox Treasury View in March 1929 is far from clear. Alan Gaukroger in his doctoral dissertation on Hawtrey’s career at the Treasury provides much helpful background information. Apparently, Hawtrey’s position was elevated into the “orthodox Treasury View” because Churchill required some authority on which to rely in opposing Liberal agitation for public-works spending which the Conservative government and Churchill’s top Treasury advisers and the Bank of England did not want to adopt for a variety of reason. The “orthodox Treasury View” provided a convenient and respectable doctrinal cover with which to clothe their largely political opposition to public-works spending. This is not to say that Churchill and his advisers were insincere in taking the position that they did, merely that Churchill’s position emerged from on-the-spot political improvisation in the course of which Hawtrey’s paper was dredged up from obscurity rather than from applying any long-standing, well-established, Treasury doctrine. For an illuminating discussion of all this, see chapter 5 (pp. 234-75) of Gaukroger’s dissertation.

I have seen references to the Treasury View for a very long time, probably no later than my first year in graduate school, but until a week or two ago, I had never actually read Hawtrey’s 1925 paper. Brad Delong, who has waged a bit of a campaign against the Treasury View on his blog as part of his larger war against opponents of President Obama’s stimulus program, once left a comment on a post of mine about Hawtrey’s explanation of the Great Depression, asking whether I would defend Hawtrey’s position that public-works spending would not increase employment. I think I responded by pleading ignorance of what Hawtrey had actually said in his 1925 article, but that Hawtrey’s explanation of the Great Depression was theoretically independent of his position about whether public-works spending could increase employment. So in a sense, this post is partly belated reply to Delong’s query.

The first thing to say about Hawtrey’s paper is that it’s hard to understand. Hawtrey is usually a very clear expositor of his ideas, but sometimes I just can’t figure out what he means. His introductory discussion of A. C. Pigou’s position on the wisdom of concentrating spending on public works in years of trade depression was largely incomprehensible to me, but it is worth reading, nevertheless, for the following commentary on a passage from Pigou’s Wealth and Welfare in which Pigou proposed to “pass behind the distorting veil of money.”

Perhaps if Professsor Pigou had carried the argument so far, he would have become convinced that the distorting veil of money cannot be put aside. As well might he play lawn tennis without the distorting veil of the net. All the skill and all the energy emanate from the players and are transmitted through the racket to the balls. The net does nothing; it is a mere limiting condition. So is money.

Employment is given by producers. They produce in response to an effective demand for products. Effective demand means ultimately money, offered by consumers in the market.

A wonderful insight, marvelously phrased, but I can’t really tell, beyond Pigou’s desire to ignore the “distorting veil of money,” how it relates to anything Pigou wrote. At any rate, from here Hawtrey proceeds to his substantive argument, positing “a community in which there is unemployment.” In other words, “at the existing level of prices and wages, the consumers’ outlay [Hawtrey’s term for total spending] is sufficient only to employ a part of the productive resources of the country.” Beyond the bare statement that spending is insufficient to employ all resources at current prices, no deeper cause of unemployment is provided. The problem Hawtrey is going to address is what happens if the government borrows money to spend on new public works?

Hawtrey starts by assuming that the government borrows from private individuals (rather than from the central bank), allowing Hawtrey to take the quantity of money to be constant through the entire exercise, a crucial assumption. The funds that the government borrows therefore come either from that portion of consumer income that would have been saved, in which case they are not available to be spent on whatever private investment projects they would otherwise have financed, or they are taken from idle balances held by the public (the “unspent margin” in Hawtrey’s terminology). If the borrowed funds are obtained from cash held by the public, Hawtrey argues that the public will gradually reduce spending in order to restore their cash holdings to their normal level. Thus, either way, increased government spending financed by borrowing must be offset by a corresponding reduction in private spending. Nor does Hawtrey concede that there will necessarily be a temporary increase in spending, because the public may curtail expenditures to build up their cash balances in anticipation of lending to the government. Moreover, there is always an immediate effect on income from any form of spending (Hawtrey understood the idea of a multiplier effect, having relied on it in his explanation of how an increase in the stock of inventories held by traders in response to a cut in interest rates would produce a cumulative increase in total income and spending), so if government spending on public works reduces spending elsewhere, there is no necessary net increase in total spending even in the short run. Here is how Hawtrey sums up the crux of his argument.

To show why this does not happen, we must go back to consider the hypothesis with which we started. We assumed that no additional bank credits are created. It follows that there is no increase in the supply of the means of payment. As soon as the people employed on the new public works begin to receive payment, they will begin to accumulate cash balances and bank balances. Their balances can only be provided at the expense of the people already receiving incomes. These latter will therefore become short of ready cash and will curtail their expenditures with a view to restoring their balances. An individual can increase his balance by curtailing his expenditure, but if the unspent margin (that is to say, the total of all cash balances and bank balances) remains unchanged, he can only increase his balance at the expense of those of his neighbours. If all simultaneously try to increase their balances, they try in vain. The effect can only be that sales of goods are diminished, and the consumers’ income is reduced as much as the consumers’ outlay. In the end the normal proportion between the consumers’ income and the unspent margin is restored, not by an increase in balances, but by a decrease in incomes. It is this limitation of the unspent margin that really prevents the new Government expenditure from creating employment. (pp. 41-42)

Stated in these terms, the argument suggests another possible mechanism by which government expenditure could increase total income and employment: an increase in velocity. And Hawtrey explicitly recognized it.

There is, however, one possibility which would in certain conditions make the Government operations the means of a real increase in the rapidity of circulation. In a period of depression the rapidity of circulation is low, because people cannot find profitable outlets for their surplus funds and they accumulate idle balances. If the Government comes forward with an attractive gild-edged loan, it may raise money, not merely by taking the place of other possible capital issues, but by securing money that would otherwise have remained idle in balances. (pp. 42-43)

In other words, Hawtrey did indeed recognize the problem of a zero lower bound (in later works he called it a “credit deadlock”) in which the return to holding money exceeds the expected return from holding real capital assets, and that, in such circumstances, government spending could cause aggregate spending and income to increase.

Having established that, absent any increase in cash balances, government spending would have stimulative effects only at the zero lower bound, Hawtrey proceeded to analyze the case in which government spending increased along with an increase in cash balances.

In the simple case where the Government finances its operations by the creation of bank credits, there is no diminution in the consumers’ outlay to set against the new expenditure. It is not necessary for the whole of the expenditure to be so financed. All that is required is a sufficient increase in bank credits to supply balances of cash and credit for those engaged in the new enterprise, without diminishing the balances held by the rest of the community. . . . If the new works are financed by the creation of bank credits, they will give additional employment. (p. 43)

After making this concession, however, Hawtrey added a qualification, which has provoked the outrage of many Keynesians.

What has been shown is that expenditure on public works, if accompanied by a creation of credit, will give employment. But then the same reasoning shows that a creation of credit unaccompanied by any expenditure on public works would be equally effective in giving employment.

The public works are merely a piece of ritual, convenient to people who want to be able to say that they are doing something, but otherwise irrelevant. To stimulate an expansion of credit is usually only too easy. To resort for the purpose to the construction of expensive public works is to burn down the house for the sake of the roast pig.

That applies to the case where the works are financed by credit creation. In the practical application of the policy, however, this part of the programme is omitted. The works are started by the Government at the very moment when the central bank is doing all it can to prevent credit from expanding. The Chinaman burns down his house in emulation of his neighbour’s meal of roast pork, but omits the pig.

Keynesians are no doubt offended by the dismissive reference to public-works spending as “a piece of ritual.” But it is worth recalling the context in which Hawtrey published his paper in 1925 (read to the Economics Club on February 10). Britain was then in the final stages of restoring the prewar dollar-sterling parity in anticipation of formally reestablishing gold convertibility and the gold standard. In order to accomplish this goal, the Bank of England raised its bank rate to 5%, even though unemployment was still over 10%. Indeed, Hawtrey did favor going back on the gold standard, but not at any cost. His view was that the central position of London in international trade meant that the Bank of England had leeway to set its bank rate, and other central banks would adjust their rates to the bank rate in London. Hawtrey may or may not have been correct in assessing the extent of the discretionary power of the Bank of England to set its bank rate. But given his expansive view of the power of the Bank of England, it made no sense to Hawtrey that the Bank of England was setting its bank rate at 5% (historically a rate characterizing periods of “dear money” as Hawtrey demonstrated subsequently in his Century of Bank Rate) in order to reduce total spending, thereby inducing an inflow of gold, while the Government simultaneously initiated public-works spending to reduce unemployment. The unemployment was attributable to the restriction of spending caused by the high bank rate, so the obvious, and most effective, remedy for unemployment was a reduced bank rate, thereby inducing an automatic increase in spending. Given his view of the powers of the Bank of England, Hawtrey felt that the gold standard would take care of itself. But even if he was wrong, he did not feel that restoring the gold standard was worth the required contraction of spending and employment.

From the standpoint of pure monetary analysis, notwithstanding all the bad press that the “Treasury View” has received, there is very little on which to fault the paper that gave birth to the “Treasury View.”

Margaret Thatcher and the Non-Existence of Society

Margaret Thatcher was a great lady, and a great political leader, reversing, by the strength of her character, a ruinous cycle of increasing state control of the British economy imposed in semi-collaboration with the British trade unions. That achievement required not just a change of policy, but a change in the way that the British people thought about the role of the state in organizing and directing economic activity. Mrs. Thatcher’s greatest achievement was not to change this or that policy, but to change the thinking of her countrymen. Leaders who can get others to change their thinking in fundamental ways rarely do so by being subtle; Mrs. Thatcher was not subtle.

Mrs. Thatcher had the great merit of admiring the writings of F. A. Hayek. How well she understood them, I am not in a position to say. But Hayek was a subtle thinker, and I think it is worth considering one instance — a somewhat notorious instance — in which Mrs. Thatcher failed to grasp Hayek’s subtlety. But just to give Mrs. Thatcher her due, it is also worth noting that, though Mrs. Thatcher admired Hayek enormously, she was not at all slavish in her admiration. And so it is only fair to recall that Mrs. Thatcher properly administered a stinging rebuke to Hayek, when he once dared to suggest to her that she could learn from General Pinochet about how to implement pro-market economic reforms.

However, I am sure you will agree that, in Britain with our democratic institutions and the need for a high degree of consent, some of the measures adopted in Chile are quite unacceptable. Our reform must be in line with our traditions and our Constitution. At times the process may seem painfully slow. But I am certain we shall achieve our reforms in our own way and in our own time. Then they will endure.

But Mrs. Thatcher did made the egregious mistake of asserting “there is no such thing as society, just individuals.” Here are two quotations in which the assertion was made.

And, you know, there is no such thing as society. There are individual men and women, and there are families. And no government can do anything except through people, and people must look to themselves first. It’s our duty to look after ourselves and then, also to look after our neighbour. People have got the entitlements too much in mind, without the obligations, because there is no such thing as an entitlement unless someone has first met an obligation.


There is no such thing as society. There is living tapestry of men and women and people and the beauty of that tapestry and the quality of our lives will depend upon how much each of us is prepared to take responsibility for ourselves and each of us prepared to turn round and help by our own efforts those who are unfortunate.

In making that assertion, Mrs. Thatcher may have been inspired by Hayek, who wrote at length about the meaninglessness of the concept of “social justice.” But Hayek’s point was not that “social justice” is meaningless, because there is no such thing as society, but that justice, like democracy, is a concept that has no meaning except as it relates to society, so that adding “social” as a modifier to “justice” or to “democracy” can hardly impart any additional meaning to the concept it is supposed to modify. But the subtlety of Hayek’s reasoning was evidently beyond Mrs. Thatcher’s grasp.

Here’s a wonderful example of Hayek talking about society.

In the last resort we find ourselves constrained to repudiate the ideal of the social concept because it has become the ideal of those who, on principle, deny the existence of a true society and whose longing is for the artificially constructed and the rationally controlled. In this context, it seems to me that a great deal of what today professes to be social is, in the deeper and truer sense of the word, thoroughly and completely anti-social.

Nevertheless, while Mrs. Thatcher undoubtedly made her share of mistakes, on some really important decisions, decisions that really counted for the future of her country, she got things basically right.

Remembering Armen Alchian

On March 23, a memorial service celebrating the life of Armen Alchian was held at UCLA. David Henderson was there and shared some vignettes from the service.

Here is a webpage with pictures from the memorial.

Here is a tribute to Alchian by one of his finest students, Stephen N. S. Cheung. I found this passage especially moving, but follow the link and read the entire eulogy by Cheung.

Back in the old days at UCLA, it was not easy for graduate students to discuss research ideas with Alchian in person.  Most students harbored the impression that he was aloof and not very approachable.  I shared the same view initially, but discovered the contrary later.  The following is a true story.

In early 1967, after finishing the first lengthy chapter of my thesis, I received news from Hong Kong that my elder brother (who was a year older) had passed away.  Understanding that my mother must be shattered by the death of her favorite son, I thought about giving up at UCLA and returning to Hong Kong to be near her.  At that time I was already an assistant professor at the California State University at Long Beach.  I drove back to LA to tell Jack Hirshleifer the sad news and my intention to quit.  Hirshleifer thought that it would be a pity to abandon my dissertation, on which I had already made very good progress.  He then said he would discuss with other members of my thesis committee the possibility of granting me a PhD on the strength of the first long chapter alone.

That afternoon I went to see Alchian, planning to tell him what I told Hirshleifer.  Alchian obviously knew what I had in mind.  But before I had a chance to say anything, he said, “Don’t tell me anything about your personal matters.”  So I left without a word.  One day later in Long Beach, I received a letter from Alchian with a $500 check enclosed and simply two lines: “You can buy candies with this $500 or you can hire a typist to help you finish your dissertation as quickly as possible.”  This $500 was equivalent to my one month’s gross salary, so it was not a small amount.  What other alternatives did I have?  In less than two months I wrapped up my dissertation.  Alchian said it was a miracle.  In retrospect, I regret cashing that check and spending that $500.  If I had kept the check, I could now show it to my children, grandchildren, and students while telling them this proud story.  I know Armen would say, “Steve, put that check up for auction and see how much it would fare now.”

Here is another eulogy from the same website, and another eulogy from that website — in Chinese!

Here are remembrances from some of Alchian’s UCLA colleagues, including David Levine, John Riley and Harold Demsetz.

Here is the obituary about Alchian from the Los Angeles Times.

And finally (for now), here is a video clip of Alchian speaking about property rights.

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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