Hyperinflation?

Note: I’m too tired to do a thorough proofread of this so sorry if there are a lot of typos.

Ok so I tried to argue that Austrians are too fixated on hyperinflation on Mises.org and got told

Download the pdf file from Henry Hazlitt’s book. Should help in your dilemma.

So I did that.  I didn’t read it front to back but I perused it and it actually did help with “my dilemma.”  My dilemma, just to clarify, was my inability to understand why the author of the post had spent the whole time explaining why so-called expansionary monetary policy is really contractionary and then at the end suddenly predicted hyperinflation.  And I think I know why now.

There is a fundamental inconsistency with the way Austrians (I’m taking Hazlett along with some people on blogs and that I see on tv and other places who seem to share this view and calling them “Austrians.”) treat inflation.  It has to do with expectations.  Do people expect the inflation or not?

To see the inconsistency take their moral treatment of inflation:

It reminds us that inflation is nothing but a great swindle, and that this swindle is practiced in varying degrees, sometimes ignorantly and sometimes cynically, by nearly every government in the world. This swindle erodes the purchasing power of everybody’s income and the purchasing power of everybody’s savings. It is a concealed tax, and the most vicious of all taxes. It taxes the incomes and savings of the poor by the same percentage as the incomes and savings of the rich. It falls with greatest force precisely on the thrifty, on the aged, on those who cannot protect themselves by speculation or by demanding and getting higher money incomes to compensate for the depreciation of the monetary unit.

Here, apparently he assumes that people are unaware of this inflation, at least at some point–that it is “concealed.”  At this point, let me head off the argument that I know will come if any Austrian reads this.  I know that the payments fall unevenly on different people and it therefore redistributes wealth, and I know Hazlitt makes that argument later.  I’m not trying to say inflation is perfectly moral I’m just pointing out the implicit assumption about expectations that he seems to be making.  This assumption is even more clear when he talks about the public debt.

When it was pointed out to the Eisenhower Administration, as it was to its Democratic predecessors, that our huge national debt continues to mount, a favorite defense was that it had not risen as a percentage of the national income. Such a reply ignores the fact that the national income has gone up (in dollar terms) in large part because prices have gone up, and that prices have gone up because of the currency debasement brought about partly by the very deficit financing that increased the debt. What this defense amounts to, in short, is a boast that the burden of the national debt has not increased because it can now be paid off in debased dollars.

See it’s a simple moral argument: the government borrows money then “debases” the currency, the pays back the loan with less valuable dollars, thereby stealing some amount of wealth from the public.  But this is only the case if the public doesn’t expect the devaluation.  If they do, then they lend knowing full well that the dollars they receive will be worth less and understanding the real rate of return that this implies, in which case it is a mutually voluntary exchange which surely no true Austrian could object to.

But this is altogether different from the assumption about inflation expectations that leads to the conclusion of hyperinflation.  Look what he says.

He was at times indiscreet enough to suggest that a price rise of 2 or 3 per cent a year would be about right. It has been pointed out, however, that even if we could control an inflation to a rate of 2 per cent a year it would mean an erosion of the purchasing power of the dollar by about one-half in each generation.

Even so, this would not accomplish Slichter’s announced purpose. He thought prices must go up this much in order to meet the unions’ annual wage demands. But the moment Slichter’s inflation scheme was openly put into effect, as I have already pointed out in Chapter 27, union leaders would simply add 2 per cent (or whatever the planned annual inflation was) on top of the demands they would have made anyway. In fact, lenders, investors, manufacturers, retailers, speculators would all mark up their demands or change their operations to beat the inflation, which would thereupon race to a crack-up. A declining currency must eventually obey the law of acceleration that applies to all falling bodies

Here he assumes that if there is a little inflation, it causes expectations to adjust and that causes all prices to account for the inflation and that causes expectations to adjust further causing prices to adjust further and this process gets out of control and causes hyperinflation.  So the treatment of expectations is not very consistent here.  Furthermore, this seems to be the same logic that Polleit falls into in the post.

Rising interest rates threaten to bring down leveraged banks. Defaulting banks would reduce the fiat-money stock. So to prevent the fiat-money stock from declining in a bust, the central bank has to keep market interest rates low.

However, the outlook of ongoing debt monetization through the central bank could provoke selling pressures in bond markets: investors, concerned about higher inflation, start dumping bonds, thereby pushing up market interest rates.

The central bank would then have to purchase ever-greater amounts of debt, thereby issuing ever-greater amounts of fiat money. The ongoing attempt to keep down the interest rate to prevent the fiat-money stock from declining could easily lead toward a policy of high inflation, even hyperinflation.

Here we can pinpoint a more important mistake.  As I said before, he is saying pretty much exactly what I have been saying up until the end of the first paragraph above.  Most essentially that “to prevent the fiat-money stock from declining in a bust, the central bank has to keep market interest rates low.”  The reason they are keeping them low is to keep the money stock from declining.  This highlights the confusion which I think is often present in both Austrian and more mainstream schools between policy goals and policy methods.

The whole objective of the central bank is to sustain moderate positive inflation (in prices).  This is what the economy expects (because they tell us to expect it) so if inflation is less than that it causes problems (I’ve been over this before so I won’t try to do it again here).  The problem is that in order to maintain that inflation they have to offer lower and lower interest rates for all the reasons Polleit explains in his post and I explain in this one.   The low interest rates are not the goal they are the means.  The point of the policy is to inflate the money supply.

At this point notice that the demand and supply for loans need not be equal here.  In fact the whole money creation mechanism requires them to not be equal since the new money comes in basically to fill the gap.  The Fed picks an interest rate and then buys whatever quantity of securities achieves it “in the market.”  This is the same as saying they pick an interest rate and create money in the amount of the resulting shortage of loanable funds.  This is why they need to keep lowering the rate because when the contractionary forces start catching up with them they have to create more and more money which means they have to create a larger and larger shortage in the market for loanable funds.  If they fail to do this prices will start to fall as the money supply dries up and then the expectations of inflation will fall as well (most likely) and you will get a deflationary spiral.

The way Hazlitt and Polleit go wrong is to miss the reason the Fed is lowering rates.  Hazlitt treats low rates as the goal of Fed policy and inflation as a side effect.

The expansion of money and credit that is necessary to hold interest rates down also raises commodity prices and wages. Higher commodity prices and wages make it necessary for businessmen to borrow correspondingly more in order to do the same volume of business. Therefore the demand for credit soon increases as fast as the supply. Later on, still another factor comes in. When both borrowers and lenders begin to fear that inflation is going to continue, prices and wages begin to go up more than the increase in the supply of money and credit. Borrowers want to borrow still more to take advantage of the expected further rise in prices, and lenders insist on higher interest rates as an insurance premium against expected depreciation in the purchasing power of the money they lend.

But this is not the case, their goal is to create inflation and low interest rates are the mechanism.  If expected inflation actually increased (which I see no reason to expect in such an environment) it is true, as Polleit says, that the supply of bonds would increase (which is basically the same as saying either the demand for loans increases or the supply decreases).  But this would make the gap between supply and demand in the loanable funds market that much greater for any given interest rate which is exactly what the Fed wants.  This would allow them to accomplish the desired inflation of the money supply at a higher interest rate than otherwise, potentially eliminating the zero interest rate problem.  So there’s no reason to not expect them to just let rates increase if they are able to get the money out there at higher rates.  Low rates are not the goal inflation is the goal.  The rates could be allowed to increase as much as was required to arrest inflation (both real and expected) at the desired level.  The danger is on the deflationary side.

Furthermore, Hazlitt makes an empirical argument:

He (Slichter) declared that it was “incorrect” to believe that “creeping inflation is bound sooner or later to become galloping inflation,” because this had not happened in the preceding twenty-five years in the United States. Yet our cost of living had more than doubled in the preceding seventeen years, which was something more than a creep. Slichter might have taken a look at the French franc, which was then already at considerably less than one-hundredth of its 1914 purchasing power; or at the median loss of one-third of their value by 42 different currencies in the preceding nine years alone (as pointed out in Chapter 24).

But a doubling of the price level in 17 years amounts to an inflation rate of about 4%.  Ok it’s 1 % higher than what  Slichter said would be ideal but it’s certainly closer to creeping than to hyperinflation.  What’s more, even if it had increased five-fold in the same time, this would not be evidence of the hyperinflation-spiral theory.  In order to support that theory we would have to observe increasing rates of inflation which we haven’t, including the 50 years since this article was written.  It goes up and down but it doesn’t look like anything other than a stationary process empirically (of course I’m arguing that eventually it won’t be but in the deflationary direction not inflationary).  And there is no strong evidence of this in the table of countries in chapter 24 either, again, some have high inflation and some low and some have increasing and some decreasing.

Hyperinflation comes from a different kind of monetary system than what we have.  It occurs when the government has the ability to print money directly and spend it.  Ours doesn’t work that way.  The Federal reserve prints the money.  The government is not a king who can add impurities to the coin or a dictator who runs the government via the printing press.  It has to borrow what it spends.  This means that the money is not backed by nothing it is backed by debt and collateral.  In order for a hyperinflation to happen money would have to be freed from it’s association with debt.  And even if it were, there is still no reason to believe that it couldn’t keep it at a “creep” forever only that it probably wouldn’t (I’m not advocating we try it).

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  1. steve618
    September 22, 2011 at 4:15 am

    Hazlitt’s book does a pretty thorough job of discussing the myriad effects of inflation, but he doesn’t discuss deflation at all. Also, defining inflation as the increase in the supply of money he then goes on to say that the cause of inflation is the increase in the supply of money. Huh? The cause of inflation is …inflation? A rather simple tautology I’d say. At least he gives some credit to the role psychology plays and cautions against relying solely on mechanistic cause-effect explanations for phenomena associated with inflation.
    In my opinion the Austrian adherents are missing a great opportunity to point out a trend change as it is occuring. The evidence is staring them in the face and all they can seem to do is extrapolate the previous, long established, but aging, trend on into the future. By the time the evidence is too overwhelming for them to ignore, it will be too late to take timely action (or credit for forecasting a major trend change).

    • Free Radical
      September 22, 2011 at 5:09 pm

      Yeah this is pretty much how I feel about it.

  2. Anonymous
    September 22, 2011 at 2:36 pm

    Mr. Radical–

    Given your perceptive analysis demonstrating the serious flaws in standard Austrian thinking, how can you still say you side with the Austrians? If we went back to the “gold standard”, isn’t it obvious to you that the effect would be dramatically defationary. WIth a fixed money supply chasing ever expanding economic output, prices would decrease to enable the fixed money supply to purchase the increased range of available goods and services.

    Further, if you look at the economy during the 19th century, when we had a system which I think was fairly close to what the Austrians–and I think you–promote, we had a series of booms and busts, with a recession (or depression) happening every couple of years. There were almost as many years in recession or depression as in expansion and there were relatively short periods between economic downturns. Who would want to go back to that system? If you examine the major world economies in the early to mid part of the 20th century, the quicker a country abandoned a strict “gold standard” the sooner it began to grow (I know you read Matt Yglesias, so I assume you have seen the chart on this issue).

    While our current system is by no means perfect, it seems to avoid the repeated quick periods of expansion and conraction we used to see in the 19th century and allows the money supply to increase as the ability of the economy to create more value increases. You also express agreement with the approach of our current model to the extent that this money supply increase is accomplished through debt issued by the Fed rather than merely “printing money” (which Treasury actually could do legally through “seignorage” using high-denomination platinum coins but wisely does not take advantage of this option) in order to eliminate any serious risk of hyper-inflation.

    So I repeat, given your seeming understanding of these basic points, how can you still side with the Austrians?

    Z

    • Free Radical
      September 22, 2011 at 5:24 pm

      This is a great question and I think it will be hard to answer thoroughly in a comment but I will give a general answer and try to address it more carefully in the future (I have tried in the past but it’s an ongoing process). Unlike the Austrians, I am not concerned about hyperinflation. I am concerned about deflation. But unlike Keynesians (and monetarists and basically most mainstream types) I am not concerned about deflation per se. Yes if you returned to a gold standard it would be deflationary (technically what I want is just free money not necessarily a hard gold standard). Of course this would be pretty tricky to accomplish and I’m not very optimistic about it happening without a large scale economic collapse. And yes if you had a gold standard you would probably have somewhat steady deflation over time (note though that the supply of money under a gold standard is not “fixed,” the supply of gold still increases over time, other things could be used for money and most importantly credit could still expand and contract on top of the monetary base.) But I don’t think this would be any great catastrophe.

      I do think the deflation that will eventually kick in from the current system will be a great catastrophe. The simple reason is that the whole system is designed to influence people’s expectations of inflation to make them something that, in my opinion, is not sustainable inefinitely. So they make decisions based on these expectations and then when the expected inflation doesn’t materialize it is highly disruptive. The end result being that the central bank and/or the federal government own/control practically all the wealth in the country. Since i am ideologically on the side of Austrians (libertarian) this is not a desirable outcome to me even if it means we have higher GDP for a while on the way there.

      I can’t really say much on the empirical side here but I will at least point out that the system in the 19th century wasn’t exactly what I have in mind and also that I don’t think you would never have a recession even if you did have exactly what I want. Markets will always move up and down.

      • Anonymous
        September 22, 2011 at 9:23 pm

        I would like to go through these ideas in more detail. Before I can do that, I need to know your definition of “free money.” Do you mean a dollar, the value of which is pegged to a specifically defined basket of commodities (or other traded assets) or do you mean something else?

        Z

    • Free Radical
      September 22, 2011 at 5:32 pm

      By the way, I didn’t know that about the treasury and platinum coins. That’s interesting.

    • Free Radical
      September 22, 2011 at 10:19 pm

      I mean the government having no monetary policy whatsoever and just letting people trade whatever they want for whatever they want. Most likely this would mean that gold and/or some other precious metal would become the standard unit of exchange but we don’t need the government to decide what we can use as money. If there “wasn’t enough” gold (as is commonly argued, though in my opinion incorrectly) you could use silver, or copper, or platinum, or pork belly futures or whatever.

      • Free Radical
        September 22, 2011 at 10:24 pm

        Just one more comment on that: The government does have to specify one thing and that is the form in which taxes must be calculated and paid. I would recommend gold for this since it’s the most common form of money that has existed historically and that would probably encourage its use as a general measure of value to some extent. But you wouldn’t have laws forcing you to accept gold or forbidding you from contracting in any other form of payment.

    • January 25, 2014 at 12:25 am

      StagflationUltimately the gov can steer the ship in any direction it wants, and iontalifn is the only politically easy way to defuse the debt bomb.IMO fed is likely to cut 25 bp Sept 18. This is a freebie because FF is already trading at 5% anyway. Any cut that’s bigger or sooner sends the wrong signal. I mean, all the passengers on the plane can look out the window and see the engines are on fire. 25 bp on Sept. 18 will feel like the pilot is still trying to fly the aircraft in for some kind of landing. 50 bp prior to Sept. 18 will feel like you see him setting the autopilot while strapping on a chute.I’m looking for some major non-Fed action to try to reduce the bleeding. Conforming limit bump would help improve liquidity and is OK with me provided credit standards are still high. That will help creditworthy current owners refi and creditworthy borrowers buy RE if they want to. I expect some sort of giant patch for the rest. Gov will go to the lenders and triage the FBs – there are some who could and would keep servicing the debt despite being upside-down, if only they could get a fixed-rate mortgage at a rate that is not usurous. Some sort of loan guarantee program will be rolled out to make it happen. Gov doesn’t even need to hold a gun to the lender’s head, because they are already holding guns to their own heads and begging someone to stop them from pulling the trigger.The observation about the likely effect of declining rates on bank deposits is one I had not considered but rings true. I was burned when Easy Al took rates down to 1%, heck even at 5% I’m losing money to iontalifn after taxes. For damned sure I’m not going to just lie back and take it again – I’ll buy stocks, gold, even RE if I have to. So, like, yeah, cuts down to Japanese interest rates don’t seem to be in the cards this time around.Gov needs to do something to encourage savers, instead we will likely have a Democrat anxious to “soak the rich” with even higher taxes eating into the already-negative real returns on bank deposits. I really feel like a chump when I think about it.

    • attila
      January 25, 2014 at 9:12 am

      deflation is not the end of the world, and there are different kinds of deflation, too.

      in more details:

      The #Deflationary Spiral Bogey (presents the deflation boogie, then points out some obvious oversimplifications)
      https://mises.org/daily/6362/The-Deflationary-Spiral-Bogey
      http://www.zerohedge.com/news/2013-02-14/guest-post-deflationary-spiral-bogey

      http://www.zerohedge.com/news/2014-01-22/peter-schiff-destroys-deflation-ogre-myth

      https://mises.org/daily/6459/Whats-So-Scary-About-Deflation

      • Free Radical
        January 30, 2014 at 8:41 am

        I wrote a detailed response to these here:
        http://realfreeradical.com/2014/01/30/still-more-on-hyperinflation/

      • attilalendvai
        January 30, 2014 at 11:04 am

        Free Radical :
        I wrote a detailed response to these here:
        http://realfreeradical.com/2014/01/30/still-more-on-hyperinflation/

        i think you’re attacking a strawman there.

        i can’t talk for others, because you seem to slump together everyone into one austrian group, but at least *my* intention was to draw the attention of the commenters that there’s nothing wrong with deflation *in general*. what’s wrong is the current monetary system, that people have been blowing a balloon of bullshit for about a hundred years now, enabling a huge wealth transfer. but you’ve also stated this (although with nicer words).

        so, yes, in the current context a deflation (or a hyperinflation) will be ugly, but it will happen nevertheless. there are simply too many parasites sucking less and less productivity, and that calls for a collapse of the host, one way or another.

      • Free Radical
        January 30, 2014 at 7:18 pm

        It’s a straw man you posted… but I guess we are mostly on the same page then (though a lot of other people don’t seem to think it is a straw man). The problem is the “one way or another.” If Austrians just keep acting like deflation is no big deal and we actually get some, the devastation which will come from it will greatly discredit the libertarian movement that has embraced that kind of flawed thinking. If you want to convince people there’s a problem you have to accurately identify it and have some idea of how it could be fixed without destroying the whole economy.

  3. September 22, 2011 at 5:00 pm

    I thought the article was very well thought out. The logic seems sounds to me. However, the comment above definitely lacks some knowledge of history and logic. During the 19th century we still had the First and Second Banks of the United States, as well as state banks, interfering with the money supply. Even so, that century was the greatest economic expansion in world history, in the United States and elsewhere. That is the century that America became the wealthiest nation on earth!

    Also, I think minor recessions are not bad, and even necessary. It is just the market readjusting itself to its more efficient state, which is good for true economic growth.

    • Free Radical
      September 22, 2011 at 5:25 pm

      Well said Thomas.

      • May 15, 2017 at 3:47 pm

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    • Anonymous
      September 22, 2011 at 9:28 pm

      The nineteenth century may have been an incredible period of economic expansion (largely due to the transition from an agrarian to urban society and other developments following the industrial revolution), but if you really think the monetary system was better then, consider the charts from the following URLs:

      http://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States
      http://en.wikipedia.org/wiki/File:US_Historical_Inflation_Ancient.svg

      These charts seem to demonstrate that we do a much better job of handling recessions and inflation since we went off the gold standard and introduced the Fed and the issuance of “fiat” money. Look at the change over time in the serverity of recessions, the length of time between them, the amount of deflation we used to experience on a regular basis, etc. The stability resulting from our current system seems emperically better by a wide margin.

      Z

    • Anonymous
      September 22, 2011 at 9:56 pm

      The 19th century may have been a great expansive century (largely due to the industrial revolution and changes from an agrarian to urban society), but if you think their monetary system was better, please go to the following URLs:

      http://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States
      http://en.wikipedia.org/wiki/File:US_Historical_Inflation_Ancient.svg

      I think these charts demonstrate that we do a much better job now dealing with issues of recession and inflation. The 19th century had more frequent and deeper recessions with repeated periods of deflation (quick booms and busts). The advent of the Fed and fiat money seem to have improved these economic fluctuations and downturns. These recessions were not just minor recessions either. Look at the statistics please.

      Z

      • Free Radical
        September 22, 2011 at 10:38 pm

        I will let Thomas handle the empircal argument if he wants. I don’t really have such an argument to make since I am predicting something that is largely hitherto unobserved (although the great depression offers a pretty good analogue). I’m not saying you can’t make the economy run somewhat smoothly for a while. I’m just saying that you can’t do it forever (at least not without fundamentally changing the system). And I think we are witnessing the beginning of the end.

  4. Free Radical
    September 22, 2011 at 11:13 pm

    Also, here is a post regarding my general stance toward Austrians and Keynesians (in whose camp I am sort of lumping many other mainstream types). Be sure to read the “poem” (this seems to be a misnomer but maybe the metre is lost in translation…) at the end to understand why I still side with the Austrians in principle.

    https://realfreeradical.wordpress.com/2011/08/18/my-god-lord-my-god-please-make-the-devil-keep-his-word/

    • Anonymous
      September 23, 2011 at 1:43 pm

      I had read that other post of yours already, and based on that post, I really don’t understand why you side with the Austrians. Let’s take your analogy more or less at face value. The Austrians are saying–let’s stick to the ground and get around however quickly and efficiently ground travel can take us. The Keynesians are saying, our modern understanding of physics (remember that the engineer also needs to be a scientist–the engieneer does not ignore science, but rather uses it in new and innovative ways) allows us to fly. Why would we not want to fly? Are there risks involved–of course–but there are different risks in not taking advantage of this new innovation. Are you suggesting that you think we should stop using airplanes (yes, I understand it is an analogy and not to be taken that literally–but still, my point remains)? Is another system better because you think it is more “natural” or more “libertarian” even if it leads to worse results for the economy and the majority of citizens?

      You say that you will let Thomas handle the empirical argument, but the emperical argument is really all that matters. If the “Keynesian” approach (although I think a lot of people who would never be considered Keynesians by most people–such as Milton Friedman and Alan Greenspan–appear to have preferred the Fed and fiat money rather than the gold standard or “free” money) leads to better “emperical” results than the “gold” standard or some other alternative, isn’t that all that matters? The Great Depression happened while we were still on the gold standard. Again, as noted above, if you look at different countries responses to this crisis (and Matt Yglesias has mentioned this multiple times), the quicker the country abandoned the gold standard, the quicker its economy begain to grow.

      Your idea of “free” money seems to me to be possible only in some “utopia” where people have perfect access to information, and therefore anyone who commits fraud is never trusted by anyone else again. The real world does not work this way. Look at the recent financial crisis. The investment banks and ratings agencies knew that they were bundling mortgages using a “formula” to rate the CMBS (collateralized mortgage backed securities) instruments that was highly suspect. But not only did the marketplace generally buy into the ratings, the people committing the fraud eventually started to believe their own lies (although near the end, the geniuses at Goldman figured out the house of cards was about to fall and shifted from heavy investment in CMBS to neutral, hedging their losses–although not until after a big internal fight at Goldman with the people in the CMBS segment arguing the opposite position). You might argue this bubble was not created by fraud but mere mistaken analysis (supported by the level of investment made by the people committing the supposed fraud), but if the person perpetuating the fraud thinks everyone has bought into the fraud, that person can make a lot of money investing with them, and it is human nature to fail to see how the fraud will eventually unravel. It is also human nature to start to believe the “big lie” as the observed empirical evidence shows the values increasing. The Big Short demonstrates how “group think” makes it difficult to see the problem when someone is in the middle. Only certain “outside the box” thinkers seemed to see that the CMBS industry was doomed.

      I agree that the Fed has made some significant mistakes over the last decade or so. Alan Greenspan refused to regulate the CMBS market after Congress gave him that power in the mid-90s. I also think that the Fed has targeted an inflation rate that is too low. The Fed seems to have convinced itself that after bringing inflation from the double digits to the 3-4% range, that things would be even better if they got inflation down to 2%. I believe that change was a mistake–the Fed should target more in the 4% range than the 2% range (in my opinion). What eventually brought conservative economists (like Milton Friedman) and liberal economists (like Paul Krugman) together was the belief that the best way to handle fluctuations in economic activity was adjustments to the interest rates (raise them to slow down the economy and lower them to stimulate the economy). These adjustments, if made correctly, should limit the booms and busts we used to experience. But interest rates are based in large part as a function of expected inflation. Targeting 2% inflation means that interest rates will be too low to give the Fed adequate room to stimulate the economy in a serious downturn (I know you argue that interest rates have come down to entice borrowers and this downward spiral will lead to an ultimate economic collapse and depression with significant deflation–but signficant deflation and depressions happened under the gold standard but not yet under our current system). I believe that this mistake by the Fed is part of the reason why the Fed has been unable to use monetary policity effectively, and led us to the “zero lower bound” problem with interest rates we face today. At that point, the Keynesians deviate from more conservative economists. Only when we reach the zero lower bound of interest rates does the Keynesian argue that fiscal stimulus is the only effective tool left to stimulate the economy back to full employment (although implicitly, the Fed must be willing to tolerate somewhat higher inflation to avoid stifling the economic growth the stimulus is trying to achieve).

      Inflation itself is not the problem–it is unexpected inflation. In fact, as long as inflation is relatively stable, higher inflation can be good for savers. For example, assume you start will $1,000,000 and invest in bonds. Assume you will spend $70,000 the first year and spend the same amount, increased by the inflation rate, for each year after that. In this example, assume inflation is stable and interest rates are 1% above this anticipated inflation. At 5% inflation and 6% interest, your money lasts about 1-1/2 years longer than if there is 2% inflation and 3% interest on your money (a simple Excel spreadsheet can demonstrate this analysis). The fear seems to be that if we let inflation go up, we may not be able to stop it from continuing to go up. But that fear is just left-over trauma from the late 70s. I am not arguing for 5% inflation per se (as noted above, 4% is probably my target), but this example is just to illustrate that unexpected inflation is the problem–not inflation itself.

      Sorry for the length of this post (and sorry for the double post above–I did not think the first one got posted), but I just found your arguments interesting but also contradictory. You seem to understand the complete lack of consistency in the Austrian arguments. You argue for “free” money (which is not really that different than the gold standard–especially if taxes have to be paid in gold), which seems to me to be completely unrealistic and I don’t see why it would not have the same boom/bust problems as the gold standard. You fear deflation, but the system you prefer seems even more likely to result in significant deflation (again–look at the charts I linked to above). I know that the libertarian theory is enticing because it seems to let the market lead to the most optimal results. But the market really does not work in the real world in a manner that allows for these results. We have “sticky prices” and “sticky wages.” We have fraud that goes unpunished. We have externalities that cannot be adequately addressed. We have collective action problems that lead to people being unable to pursue their economic interest. We have free rider problems as well. All of these inherent inefficiencies means to me that a libertarian approach simply cannot work.

      As you can probably tell, I am a liberal and a Keynesian (although one that only believes in fiscal stimulus in limited situations as noted above–probably this period being the first time since the Great Depression that truly warranted fiscal stimulus). But the Austrians have a vision of the world built on a fantasy.

    • February 6, 2013 at 10:14 am

      Keith,How many times do I have to keep telling you dude. Schiff and Roubini are both smart guys, no doubt, but they enjoy the cremaa too much. You know that. Schiff had it wrong years ago, now he is changing his tune, saying that student costs will drop. Wasn’t he saying 1 and a half ago that americans wouldn’t be able to afford anything, because everything would go through the roof with hyperinflation. Schiff, keep your stance, and stop copying Mish.I have never seen Mish on cremaa though. To me, he is the greatest economist there is. He predicted that the dollar and Yen would strengthen against all currencies. He is not a total long term bull on the dollar, but for now, it’s a hold.Mish did say that deflation can happen in a few different ways including the next ones. Everything goes down, except gold. Everything goes down, including gold.I think it is becoming clear that when money is being hoarded, investors are even willing to dump gold, to get their hands into cash. Period. I say gold and any other commodities continue to take beatings. Hell, everything is coming down, except the dollar and the yen.Dny

  5. Free Radical
    September 23, 2011 at 7:39 pm

    Ok there are many points to make here.

    1. Keynesians only believe in fiscal stimulus in limited situations. My point is that the monetary system necessarily brings those situations about. This is why we have the deficits we have, they are necessary to keep our economy running and they will have to keep expanding forever to make it work or else it will go down in a ball of deflationary flames. I can’t help but chuckle when you say only the empirical argument matters and then say this:

    “it is human nature to fail to see how the fraud will eventually unravel. It is also human nature to start to believe the “big lie” as the observed empirical evidence shows the values increasing. The Big Short demonstrates how “group think” makes it difficult to see the problem when someone is in the middle. Only certain “outside the box” thinkers seemed to see that the CMBS industry was doomed.”

    This system, by it’s construction (whether on purpose or accident) leads us perpetually into a situation where we need more and more government control and support for the economy. The analogy of a plane wasn’t meant to be carried that far (I didn’t really think it through that far) naturally I don’t think we shouldn’t have planes but that is because planes work. I think we shouldn’t have the Fed because the Fed won’t work in the end.

    2. I disagree completely that only empirical analysis matters, if that’s how you feel we will never see eye to eye. You already explained why this is the case. However I will say that while we were on the gold standard during the great depression it was after the advent of the Federal Reserve and that is really the thing I am criticizing here. That is a big difference between the gold standard that existed at the time and a “free money” system that I am talking about. You must have no centralized control of banking.

    3. You seem to have made the leap from the government not telling us what we can and can’t use for exchange to having no laws whatsoever. I’m not saying fraud shouldn’t be illegal. I’m not an anarchist, just a libertarian.

    4. Free money is not only possible in a stylized world, (this is actually true of the current system) it is no doubt more or less the situation that has prevailed in prior to centralized monetary authority in most societies. No doubt you will argue that they were much more primitive and it wouldn’t work for a modern economy or something but I disagree. This argument seems to imply that people would find no way to carry out transactions unless the government told them how. Obviously there are enormous gains from trade in a modern economy and people go to great lengths to squeeze out as much of them as possible. Look at how much work goes into writing contracts to get around the current regulations on trade. I don’t see why “liberals” seem to think that if people were left to their own devices they would suddenly have no idea how to contract.

    5. I don’t think a free market would be perfectly efficient. I study transaction costs for a living I know they exist. And I have written on this blog about how I think the most unfortunate thing to happen to free market types is for economics to have argued so convincingly in its infancy that they were perfect. This seems to have led to a place where as soon as someone points out that a free market might not be completely efficient and if there were an omniscient, omnipotent, benevolent central planner he/she could do “better” that this is justification for turning over control in some way to government. Oviously these assumptions are no less of a stretch than zero transaction costs.

    6. Just like you say with inflation, it is unexpected deflation that is bad not all deflation. With gold you would have deflation but it would be, generally, expected. Obviously things would happen and expectations would change and they wouldn’t always be right but it wouldn’t lead to incorrect expectations in a predictable way like I am arguing the current system does.

    7. Yes I would rather be free in an economy with lower economic output that not free in one with higher (at least to a point). This is what I said in my first post. It is about deciding what it’s worth to you to be free. For me it’s a lot. For others it might not be that much. But the big con is that they always ask you for your freedoms a little at a time and they don’t seem like much (usually they are actually someone else’s freedoms) and they promise big economic gains. But you have to add it all up and see where it leads. And no i don’t think we would be worse off with free markets, I think we would be better off so for me freedom wins in both respects and I try to argue that but I don’t mind admitting that this is not what the decision turns on for me.

    Also, the double post was because I had to approve them. I’m not sure why that happened that time, I think it might have been because of the links. I’m still figuring out this blogging thing. And I appreciate you taking the time to read and respond, I enjoy the lively discussion. After all that’s why we do this.

    • Anonymous
      September 23, 2011 at 9:54 pm

      Although I doubt we will ever agree (based on different values–i.e., preferred outcomes), I do enjoy the debate. I think that even though we have different views, I like to try to understand why people who disagree with me think the way they do. I will try to address each of your points in order (using the same numbering you have used).

      1. I don’t think that once every 70-80 years is a bad record for Keynesian economics. I think 1945 to 2008 is a pretty good record. That record is much better than what we had under the gold standard. The recessions post-WWII until this most recent recession should have been able to be managed by interest rate adjustments by the Fed. Significant fiscal stimulus should not have been needed during those more mild recessions. Further, the excessive deficit spending during non-recession years under Reagan, but more particularly Bush 43, made it more difficult to have the “running room” to run deficits during this downturn. I agree, however, that our system probably requires running deficits forever. I don’t see that result as a problem. As long as we keep annual deficits to around 5% of GDP, we should be fine running deficits indefinately, paying interest and continually rolling over the principal (over time making this principal a smaller percentage of the GDP). As long as the interest rate does not exceed the growth rate, there is no time limit to how long this approach can last. Many corporations work this way (capitalized by both equity and long-term debt that never gets repaid in full). Of course, if growth is smaller than the interest rate over an extended period of time, the country will have a problem. But there is no reason to assume such a result.

      2. I did not mean to suggest that ONLY emperical evidence matters. We clearly don’t have enough emperical evidence to address every possible situation, so we need to use theory as well. My point, however, is the same one that you seem to be making when you point to flaws in Austrian thinking. Specifically, if a theory suggests that something cannot happen, and then that thing happens, then there is a problem with the theory. If a theory suggest that the gold standard leads to a more stable economy, but all emperical evidence from periods where the gold stanard is used has resulted in a less stable economy, then the theory needs to be revised. Please look more closely at the links I provided above. In the 19th century, we had recessions about every 2 years. And they were deeper recessions than we have ever had post-WWII. The Great Depression is not the only depression this country has ever had. After the long depression ended in 1879 (where business activity fell over 30%), the country re-instituted the gold standard (I think it had been on silver). But even on the gold standard, three years later, another significant recession occurred with another loss of over 30% of business activity. These “booms” and “busts” are not a viable approach to a modern economy.

      3. I also did not mean to suggest that I thought you were in favor of permitting fraud. I just think fraud would be much easier to commit. If anyone is permitted to print or create a medium of exchange, how does the average person differentiate valid tender from invalid? I admit that I have very limited knowledge of pre-modern means of currency, but I am highly doubtful those means would be workable today. There are many examples of people who take advantage of others and do not get punished. They just move on to the “next sucker.”

      4. I guess I need to understand more specifically how you would envision “free money” working in a modern system. Most transctions do not involve actual paper or coin currency. As I am sure you are aware, most transaction are really just computer balances being transferred electronically from one account to another account. How exactly does this system work if we do not have a universal medium of exchange? Also, I am a corporate lawyer (and a tax lawyer), so I know quite a bit about what goes into writing contacts. I can tell you from 20 years of experience reviewing and drafting contracts that almost none of that time is spent worrying about regulations on trade. The time is spent allocating risk clearly. The buyer wants to make sure it is getting what it is paying for. So the buyer asks for lots or representations. The buyer wants to make sure that if the representations are not true, or if certain other matters cause the assets to have a lower value, the seller will have to give back part of the purchase price. Because we have freedom of contract (NOT because we are restricted through regulation in how we can contract), the permutations and combinations that are possible to address these concerns are quite varied. So time is spent negotiating how much risk each side will be willing to take regarding these issues. If the risk allocation becomes complicated, then it takes more time to draft language that clearly reflects these agreed terms. I have learned over the years that language that I originally thought was clear may not be as clear when read by someone else years later (when the term becomes relevant to a claim). So more time is spent to try to add or modify language to make the intent as unambiguous as possible. These issues are the type that generally create additional cost to a contract–not government regulation (absent some special circumstance like the anti-trust issues raised in the AT&T/T-Mobile transaction). So I absolutely believe that left to their own devices, people know how to contract. I don’t think that is the issue. But negotiations between sophisticated parties where the transaction justifies the expense of hashing out these issues in detail is quite different than common commercial transactions by unsophisticated consumers. People really do get taken advantage of all the time. Government really is the other party available to try to minimize this power imbalance.

      5. I would never want our economy controlled by a central planner (I am a liberal–not a communist). I actually want as little regulation of the economy as practical. Unfortunately, I see so many areas where I don’t think absense of regulation is practical. The basic problems with free markets are information costs, externalities and collective action/free rider problems. So we need to regulate “clean water” and “clean air” (and potentially green house gases) because the person polluting has no other way of being required to bear the cost of the externality. Ron Paul is simply incorrect that allowing the person harmed by the pollution to sue for damages would be a better system (harm wide spread, sometimes difficult to prove direct cause, litigation uncertainties, transaction cost to litigation itself, etc.). Similarly, we as a society are unwilling to let people starve in old age or go without any health care. If left to their own devices, many would not plan adequately (or be able to plan adequately). Social Security and Medicare step in and give a floor below which we will not let any person fall. Similarly, the government requires certain disclosures under securities regulations because otherwise people would not adequately disclose information. Contrary to libertarian theory, in the real world people get away with misleading others. These rules cannot avoid fraud, but safeguards are in place to make fraud less likely. Adittedly, however, the recent financial crisis shows how difficult it is to limit these problems.

      6. I think all deflation is bad. Deflation leads to reduced economic activity. The more expected the deflation, the more reduced the activity. I also don’t think most people have clear expectation of any kind. The expectation I was referred to were the expectations of market makers (who ultimately determine things such as interest rates on bonds). So having a system with perpetually anticipated deflation by market makers would be a problematic market. Borrowing would become extremely expensive (as dollars used to repay would be more expensive to get than the dollars borrowed)–talk about a real zero lower bounds problem. It would start to make sense to hoard money as it would appreciate just be keeping it unspent. Deflation is not like inflation in that respect. So deflation is bad whether anticipated or not.

      7. I think this point is the one where we perhaps have our biggest disagreement. I am not sure what you mean by freedom, but to me freedom is not the right to pollute or the right to mislead a buyer of my goods. Libertarians argue that the any action by the government takes away freedom. Please be specific. What does the government do that takes away your freedom? Do public schools take away your freedom? Does Social Security and Medicare take away your freedom? I know many libertarian think they do. But without these programs, people will fall into poverty and lose access to health care in their old age. This result is inevitable. You may be willing to let everyone take that risk, but I am not. I don’t want to live in a country where freedom means freedom to let people starve.

    • attilalendvai
      May 4, 2012 at 12:40 am

      With gold you would have deflation but it would be, generally, expected.

      inflation/deflation is used incoherently in this discussion.

      if we used gold as money, then there wouldn’t be deflation (the shrinking of the money supply).

      prices of most goods would be falling due to the constant technological advance (as long as the relation of population growth/available resources and energy/speed of technological development remains within several bounding factors)

      • Free Radical
        May 7, 2012 at 5:12 pm

        It’s not incoherent, it means what most people mean when they say inflation, namely an increase in the general price level. You are saying it is incoherent because it is different from what Austrians mean. (For the record, I specifically said “in prices” do distinguish the way I am using it from the way Austrians use it.) You can say this is the “wrong” definition if you want but then you just won’t understand what I’m talking about. It so happens that it is the useful definition. It is prices that matter. If “hyperinflation” just means an increasing money supply, and this can be achieved with stable prices, then there’s nothing to worry about. Clearly, this is not what Austrians mean when they talk about hyperinflation. If you want, you can make up a different word that means “an increase in the general price level” and insert that word wherever I say “inflation.” Of course you will also have to invent a word for “deflation.” Once you’ve done that try reading it again and see if it isn’t pretty coherent.

      • January 25, 2014 at 10:36 am

        Yeah, I remember a post over at the mogtarge lender implode-o-meter discussion board where a broker who got laid off realized she and her husband were getting in trouble themselves! She was apparently looking at bankruptcy laws, and posted whether anyone thought the recent changes in BK laws could’ve been planned.Uh, do ya’ think? No shitze, Sherlock. Bush and cronies saw problems coming down the road (and back-to-back asset bubbles were kind of a clue, no?), and decided to tighten up some of the gaps in the emergency exits to prevent sleeple from getting off without having to pay back their debt.Another little minor detail many sheeple overlook: taking out a HELOC and re-fi in essence overrides the homestead protections afforded by laws of many states when/if a person declares BK. So that little HELOC spending spree a few years before? It means the borrower is screwed out of the homestead exemption, and the home which WILL go to foreclosure if they default.Crazy coincidence, huh?

  6. Free Radical
    September 23, 2011 at 11:45 pm

    I will go through one at a time. If I get tired in the middle I will come back for the others later.

    1. Again, I’m not saying that 2008 was the result, (I mean it was the result but it wasn’t the final result). The end result will be much worse and when it happens we may very well look around and realize that we are no longer free and that will be the biggest cost of all. But more specifically I am not only predicting that we will have to run deficits forever but that they will have to increase relative to the size of the economy (as we have seen empirically). As long as the Fed is willing to keep lending them money, it can theoretically go on forever but do we really want to be that in debt collectively to a group of private bankers? (I thought the left didn’t like bankers….) Not to mention that this puts the same people who are in a position to bring about a deflationary spiral at any time–even if it is not inevitable–in the position to benefit from it at everyone else’s expense (by the way we have also observed this empirically…). Asside from the debt growing, this requires government spending to become a larger and larger proportion of the economy which is also bad if you’re a libertarian for similar reasons. These are conclusions which don’t necessarily come out of a Keynesian (for instance a DSG) model and are a main point where I differ from those types (you I guess) economically (not just morally). Not surprisingly that’s a complicated thing to show and I haven’t worked all the kinks out yet.

    2. My previous argument is basically all I have to say about this. I’m not saying the airplane won’t fly I’m saying it will eventually crash (again, not talking about airplanes but applying an imperfect metaphor.) And again, I am aware of recessions before the great depression but I still don’t agree with your premise that the monetary system was exactly what I’m advocating back then. It was a complicated history and it was changing all the time. Besides there were legitimate issues that the market would learn to deal with if it were allowed to work. Instead our response has been to demand that the government fix them. I have mentioned in previous posts how this might work. Oh and I don’t think you are suggesting this actually but just for the record I am not claiming something can’t happen that has happened (as Hazlitt did when he answered the question “can inflation creep?”) I am predicting something will happen that hasn’t happened (at least not exactly) yet.

    3. People would have to look out for themselves, that’s the cost of freedom. But you’re acting like MBS were not the direct result of government intervention in the markets (through Fannie and Freddy) which, in my opinion, is incorrect.

    Side Bar: Your question: “If anyone is permitted to print or create a medium of exchange, how does the average person differentiate valid tender from invalid?”

    Your answer: “The buyer wants to make sure it is getting what it is paying for. So the buyer asks for lots or representations. The buyer wants to make sure that if the representations are not true, or if certain other matters cause the assets to have a lower value, the seller will have to give back part of the purchase price. Because we have freedom of contract (NOT because we are restricted through regulation in how we can contract), the permutations and combinations that are possible to address these concerns are quite varied. So time is spent negotiating how much risk each side will be willing to take regarding these issues.”

    4. It’s not a power imbalance! It’s mutually beneficial exchange! The short answer is that banking would no doubt continue in a similar form to what we have now, people would have accounts and transactions would be carried out electronically but the accounts would be convertible in specie (probably gold). But anyone who could come up with a better way of doing it would stand to make a fortune putting it into practice. We don’t need to go back to the system of 1850 I’m just saying we don’t need to give special priviledges to certain people and take freedoms away from others to evolve.

    5. I agree with you that Ron Paul is wrong if he said that (I’ve never heard that). Regulating pollution doesn’t really bother me (if done correctly) but that’s not the issue (by the way you don’t need to with water trust me you would have clean water in a free market). We have a centrally manipulated economy and then whenever something bad happens we blame it on the free market! And as far as social security is concerned you are probabl right about us as a society but if that’s the case then go help these people of your free will don’t use the power of the government to force others to do it. That doesn’t make you a good person (I’m not trying to call you a bad person I’m just say in general…) The great lie of the left is to convince you that nothing gets done unless the government does it.

    6. I’m affraid you are just wrong here (although no doubt you could find an economist who would agree with you). For an explanation see this post (if you haven’t already):

    https://realfreeradical.wordpress.com/2011/03/31/monetary-theory-a-fisher-equation-approach/

    You’re actually falling into a similar trap to the Austrian hyperinflation logic. And people have to have some expectation–at least implicity. It might not be “rational” but it has to be soemthing.

    7. You are the one who keeps dragging misleading buyers into the concept of freedom. I keep saying that fraud should be illegal…. Yes medicare and public school take away my freedom. And freedom has to be the freedom to let people starve. It’s very clear and simple you would rather force other people to do what you think is right, and I would rather let them be free. There is nothing complicated to understand except that you (like pretty much everyone on the left that I have talked to) are determined to apply our words to your positions (like calling yourselves “liberals”) so you try to find ways to call taking my money against my will and maybe giving it back to me later if I survive long enough and you still have it something other than taking away my freedom to spend my life and my money the way I want. You call it “freedom from want” or something like that but these notions are the exact opposite of freedom. Freedom leaves the possibility of undesirable results and requires taking responsibility for yourself and taking PERSONAL responsibility for helping others. You can’t evade these without giving up some freedom. You might be fine with that but please don’t lie to yourself about what you are choosing, that’s all I ask.

    • Anonymous
      September 28, 2011 at 6:56 pm

      OK, I’m back. I hope you either get a notice for replies or check back periodically to old posts. I wanted to get back to you sooner, but only now got the chance. I think we finally are narrowing down the discussion to our areas of disagreement, and I think I understand your position better. I want to take another crack, however, at responding to your points in order:

      1. I think you are combining two different issues. The first issue (debt held by bankers) really has nothing to do with the deficit and relates to the Fed’s ability to issue “fiat” money. The Fed has the right to print money, so if a banker has money on deposit with the Fed, the only right the banker has is to demand fiat money in the denomination on deposit. How can this right threaten the system? As a side bar, I have been amused that paper money is denoted as a Federal Reserve Note, but the only right against the Fed is for the holder to trade the note for a different Federal Reserve Note; the wonders of fiat money (which you see as a problem and I see as a feature). The second issue, which relates to deficit directly, is the government borrowing. The borrowing is not necessarily done by banks, but by all sorts of investors (including foreign sovereigns, like China). These lenders, however, cannot threaten the US. There is no collateral for these loans. There is no redemption right, so there cannot be a “run” on the “bank” in any respect. The only risk is what interest will be required to find new lenders to “roll over” any particular debt instrument as it matures. None of these issues concern me that “private bankers” will be able to have undo control. They have undo control simply because they have a lot of money and use the influence that this money provides them to influence the political process (through donations, lobbying, etc.). The bottom line is that the US is not beholden to its lenders, its lenders are beholden to the US. As to your point regarding the growth of debt, I am skeptical that debt needs to grow indefinitely. While debt will grow as the GDP grows, it does not need to grow as a percentage of GDP. As noted in a prior post, as long as the interest rate that the bonds pay is less than the growth of GDP, we can have an annual deficit of about 5% of GDP every year, forever. The key, in my opinion, is to be responsible by running smaller deficits in good times and larger deficits during economic downturns (while generally relying on monetary policy rather than fiscal policy to deal with the economy overheating or slowing down, except for unusual periods, like now, when we are in a liquidity trap and lowering interest rates can no longer stimulate the economy). I am not sure that there is any way to “prove” which one of us is correct regarding the ability to sustain reasonable deficits indefinitely. But mathematically, my approach should work as long as the economy keeps growing.

      2. Of course your system may not have been tried exactly, but it is pretty close to the “gold standard” we had through most of our history prior to the Great Depression and prior to the formation of the Fed. Deflation stopped in 1933 as soon as Roosevelt took the country off of the gold standard. The system prior to that (and, to address you point in other posts, also prior to creation of the Fed) led to less stable results than the current system. Logic seems to dictate that if a system that is fairly close to the one you recommend led to less stable results than the current system (which is much less like the one you propose), then maybe you are incorrect that if the country just went that extra step to have truly “free money” that the system would have the desired stability. Doesn’t our experience under the gold standard suggest that your theory might be wrong?

      3. I disagree that Fannie and Freddie were the main causes of the financial crisis. I have read quite a bit about this issue, and the evidence is not really there. Yes, the head of Fannie worked to loosen the standards, but again, this loosening simply made the system more of a “free market” system. But, more to the point, Fannie’s and Freddie’s existences did not cause the sudden run up in real estate values and the improper use of CMBS instruments to package suspect loans. In fact, Fannie and Freddie’s share of the CMBS market declined during the critical years of the run up (2002-2006), during which time the private CMBS market exploded. This development in fact was fueled by investment bankers who were enabled by complicit credit rating agencies. The “geniuses” thought they had a formula that could establish when separate mortgages were not inter-related (i.e., the failure of one did not make the failure of the other more likely). In order to be able to rate a CMBS, a rating agency needs to establish a certain level on non-inter-relatedness. This formula (which only started being used around 2000-2002) was the only reason they could bundled sub-prime mortgages (inter-relatedness of higher performing mortgages could be established through more traditional methods). The formula did not work, so AAA-rated and other rated bonds (all of which should have been unrated “junk” bonds) were sold using improper pricing based on improper credit ratings. Once the cycle got started, there was so much money to be made that fraud in the writing of the mortgages became inevitable, further exacerbating the problem. None of these developments had anything to do with Fannie or Freddie. This set of events really is a classic speculative bubble which was made possible by high information costs (i.e., the cost of determining that the credit ratings were bogus). Regarding your side bar, your explanation of how “free money” would be exchanged (based on my description of private contract negotiations) only works regarding a two party transaction where the size of the transaction justifies the cost of negotiating and documenting the protections. In the real world, in such circumstances, alternative forms of currency are used all the time, primarily stock. Many acquisitions are done by paying the seller in stock of the buyer rather than cash. So in that sense, we have “free money” today. Two parties can always contract to use any medium of exchange they desire for a specified transaction. But I understand that you were talking about forms of coin or paper money (or electronic forms of currency) that would generally be recognized in the “market” as a form of “money” that could be used to purchase various goods and services. For that purpose, I just don’t see how multiple issuers of “money” could work. You say “people would have to look out for themselves.” I just don’t agree that such an ability exists for most people. How is a consumer, or a merchant for that matter, going to be able to recognize valid currency from counterfeit money? How could you be sure you were carrying (or your credit card paid the merchant) in a form of currency that the merchant would accept (especially if you are traveling)? I just don’t get it, but maybe you could explain the details in a way that could show me how it actually could work in the real world.

      4. This point is really related to the side bar discussed above. Your explanation, however, suggests that the system would pretty much work like the gold standard (at least prior to anyone coming up with a better system). Thus, I re-raise my objections to the gold standard as well as my objections to a system in which information costs become high in terms of determining the validity of currency. By the way, something just occurred to me. What reason would any private party have to create currency? Would they charge interest? If so, wouldn’t the government form of currency, which presumably would not charge interest, drive the other providers out of business by providing a cheaper product? And if we are talking about electronic forms of money, don’t we have “free money” today in the form of credit cards issued by banks, merely backed by US government “fiat” money rather than gold (and for which interest is charged if not paid in full each month), but the basic principle remains? Just some random thoughts in trying to understand what your system really means.

      5. I have a couple of points in reaction here. First, I don’t understand why you see the need for air pollution regulation but not water pollution regulation. The externalities problem (the tragedy of the commons) is basically the same. People can pollute water for which the effects are dispersed and often mainly felt miles away (e.g., downstream). While people may be willing to pay for clean water, prior to the Clean Water Act, there was a real problem of industrial pollution getting into water sources. Also, people really are not that good at determining whether they are drinking “clean” water. So the ability to sell them water that is not very healthy also is a problem. These types of externalities (combined with information costs) are a recurring problem for libertarian economics to work in the real world. Second, you indicate that it is a lie perpetuated by liberals that “nothing gets done unless the government does it.” Well, taken literally, that would be a lie. But if you substitute “certain thing would not get done” for “nothing gets done” in your sentence, then the statement is not a lie. For example, people will not save enough to live in retirement. They just won’t; it is a fact. You are willing to let them “suffer the consequences” of their actions (assuming they even had the ability to save at the time), while I don’t think that the majority of the country is willing to do so (I certainly am not). Further, certain areas of commerce involve transactions in which the market simply does not work. Medical care is the prime example, largely because people simply have little ability to separate needed care from unneeded or ineffective care and because for many people the market makes it impossible for them to be able to insure against catastrophic expenses (e.g., preexisting conditions limitations on health insurance). Certain things simply will not get done if the government does not do it. You perhaps believe that if these “certain things” don’t happen without government intervention, then that result is proof that the “thing” simply should not happen. I don’t have that view of the world. When I see a market break down resulting from high information costs, externalities or collective action concerns, I favor government action to try to correct the problem. People can differ on whether something is a problem (or whether government action can be effective addressing the problem), but in a democracy, the will of the majority should, in general, guide the result. Of course, minority rights need to be protected. I think we both agree that the protection against depravation of property without due process in an important protection, but I suspect that my interpretation of that constitutional protection is more limited than your view. Social Security and Medicare have been the most successful anti-poverty programs in our history. I don’t understand the desire to undermine these successful and important protections.

      6. I understand that you think that I am wrong about deflation, but I really believe you are the one who is mistaken. Part of my view, I believe, can be demonstrated by looking to the link you provided to me. I read your link. Go back to it. You have a meaningful mathematical error regarding the calculation of the nominal rate. Your example with 6% inflation works. You take the real rate of 10% and add the inflation rate as a negative 6%, resulting in a nominal rate of 4%. I agree with that calculation. But next you calculate the nominal rate for deflation at 8%. I believe that in that example, the nominal rate should have been 18% rather than 2%. You assumed a real rate of 10%, but when adding the “inflation” rate, you took the 8% deflation and made it negative, as you had done with the 6% inflation. That approach is not correct; when the amount if deflation, the number is positive and not negative. Thus, the nominal rate is calculated as 10% plus 8%, resulting in a nominal rate of 18%. If you think about it, this result actually makes sense. If X loans Y $100, and one year later Y pays X $110, but prices have fallen so that an item that cost $100 a year ago now only costs $92, X’s purchasing power has increased by about 18% (actually a little more than 18%). And this calculation demonstrates why I believe that deflation is always bad. The market will not settle at a nominal rate of 18%. If you expect the nominal rate to be between 0-4% (the historic norm), and deflation is expected to be more than 4%, then there is no real rate that works, assuming real rates are always positive. If, for example, you expect a nominal rate of 2%, and deflation is expected to be 8%, you would need a real rate equal to negative 6% to be economically feasible (not a positive 10%, as your example indicates). Who loans money at a negative interest rate? This “zero lower bounds” for interest rates is precisely what Keynesians worry about, and generally refer to as resulting in a liquidity trap. So the issue is not whether anticipated deflation is rational or irrational. This issue is that anticipated deflation is always bad for the economy. Thus, we need a system that tries to minimize expectations of deflation. Your recommendation of “free money” or other people’s desire to go to the gold standard (or similar system in which the “dollar” is fixed to some basket of commodities, for example) would not minimize expectations of deflation; rather, I believe such expectations would increase (and for good reason). History suggests that booms and busts become inevitable under such a system, and the busts can be quite hard to overcome. The repeated periods of deflation can freeze economic activity. People don’t invest and spend if they believe prices will go down in the future. Preserving capital becomes paramount, and waiting to spend become advisable because goods and services will become more affordable. These incentive make deflation quite destructive in a macroeconomic sense. Between the zero lower bounds for interest rates and the counterproductive incentives that result from deflation (or expectations of deflation), any system that makes deflation (or expectations of deflation) more likely is not preferable.

      7. I think this point in your post really focuses on the core of why you and I disagree. We have a completely different world view. I think we both agree that fraud should be illegal, and I don’t think I ever suggested that you promoted legalizing fraud. My point in not that the system you favor makes fraud legal; it makes fraud more likely (by making it easier to promote a fraudulent transaction). With respect to the broader issue, I think we both agree that some amount of government is necessary, so some amount of taxes is necessary. You start from the premise, however, that taxes amount to “taking [your] money against [your] will.” I view taxes as the right of the people, in a democratic republic, through the people’s representatives, to require members of the society to contribute toward the goods and services that government provides to the people. The identity of these goods and services also are determined by the people’s representatives. Of course, no system is perfect. But I prefer this system to the system that you prefer in which the government does almost nothing and thus taxes very little. I also agree with you that freedom leaves the possibility of undesirable results. Lack of freedom also obviously entails some undesirable results. This issue is not whether I believe we can avoid all undesirable results if only government would step in and fix the problems. Like you, I believe in the free market and I believe in personal responsibility. But I also believe that everyone is not given equal opportunity. I also believe that human behavior is such that most people are much better at making good short-term decisions than good long-term decisions. Moreover, no one in this society can make money without using the benefit of goods and services provided by the government, including roads and bridges (and other infrastructure), police and fire fighting services, as well as a public education which, even if not used by the individual, likely was helpful in making at least some of their employees able to perform. Once it is accepted that government must do some things and thus some taxes are appropriate to pay for these things, then it only become a judgment call for what things government should provide, and thus how high taxes have to be to pay for them. I’m sure some people have referred you to the famous folk song with the lyrics, “Freedom’s just another word for nothing left to lose.” That sentiment is my reaction to your view of the concept of freedom. I don’t know if there is any way to bridge the gap. You believe that if government is kept to the barest minimum, whatever economic consequences result are the ones that maximize freedom because you define freedom to be based largely on freedom from government intervention or interference. I look at the world and see that there is nothing inherently optimal about the current allocation of assets and opportunities, and such a system as you prefer would likely result in an ever increasing accumulation of wealth by very few, likely leading to social unrest among the masses, making a stable government more difficult to sustain. Even if these “practical” concerns regarding unrest and governmental instability never happen, the personal suffering that I believe would result from the accumulation of wealth by the few and marginalization of the rest would be intolerable to me. Private groups and charities simply would not pick up the slack. Only government can overcome this “collective action” problem to get everyone who is able to chip in to address these problems. You call this theft; I call it the result of a modern, civilized democratic republic. I believe that the people’s representatives are the appropriate decision-makers to determine which problems to try to address and how to try to address them, including how to structure the tax system to pay for these programs.

      Sorry for being so long-winded.

      Z

      • Anonymous
        October 7, 2011 at 6:46 pm

        I think I reversed my references in #6 between nominal rate and real rate, so that each reference is accidentically reversed. So I think each reference to “real rate” should read “nominal rate” and vice versa. Sorry for the error in terminology. I will answer your response at some point after you finish going through each point (at this time you have answered through #5).

  7. Free Radical
    September 29, 2011 at 5:11 pm

    1. I’m not confusing two issues, the creation of money relys on a shortage in the loanable funds market and government deficits increase demand which increases the shortage. And it’s not exactly right that that is the only right on the Fed which is granted by a FRN. It’s true of course that it doesn’t inherently grant the right to any particular asset but because they are created as debt they are convertible to the assets which guarantee the debt (houses, cars, etc.) I know you will probably say that this is a debt to a bank not to the Fed but the bank is in debt to the Fed and can “convert” them into keeping their bank. It’s more convenient to treat the whole system as one big bank for most applications. See my most recent post for more on this.

    You go to far in saying “US is not beholden to its lenders, its lenders are beholden to the US.” It is certainly not clear how an ultimate conflict would play out if the Fed and the government decided to have one. What if the Fed decides to stop buying bonds? The Fed is in position to completely tank the economy and bring the government to a screeching hault at any moment they please. But frankly I don’t think they will I think most of the people controlling one are controlling the other as well. But this setup provides justifiation for growing both. The thing i said about them using the debt as a reason to tax us even more is already playing out. It will get worse.

    The reason your approach works mathematically is that the people who do those models use simple equations for “money demand” that don’t capture the true nature of the financial system. And every Keynesian says what you are saying “it would work fine if we just ran surplusses during good times.” Maybe you’re right that the only reason we don’t is because of a lack of political will but I don’t think so. This is one area at least where my theory matches the data….

    2. No you are completely wrong to say that we had a similar system for most of our history. Even if you call the “free banking period” such a system (which I don’t) it was a period of like 30 years. Most of our history has been dominated by central banks, greenacks, going on and off the gold standard, “bimetalism” agitation etc. I really don’t think this is a productive avenue of discussion for us right now.

    3. So many problems here. I will probably write a post about it. The MBS were implicitly guaranteed by the government (and this came true). I’m so sick of progressives completely taking over an industry in ways that undermine all of the natural free market forces, putting in “regulations” to replace these forces and then removing them and saying they made the market “freer.” The things that happened in the housing market are exactly what theory would tell us would happen when the government does the things they did. If you are determined to avoid this conclusion then I have no doubt that you will be able to look at the “evidence” and find that it doesn’t prove it. But even if it has nothing to do with Fannie and Freddie, it still has everything to do with monetary policy and so this is really just a diversion from the discussion a hand.

    I am finding this very mentally taxing right now so I will come back and do more later. I am glad you came back though, I was starting to miss you. (=

  8. Free Radical
    October 5, 2011 at 1:47 am

    Ok I needed that break. I will try to do one a day or so. So we’re on number 4. First of all the point of free money is that the government should not be involved in it at all, meaning they shouldn’t compete with the private sector to create money. That’s not the proper purpose of government, they aught to stick to defining and protecting our property rights and leave the economy and everything else alone. This is the only way we could hope to remain free.

    There is nothing about this system which would cause informtaion costs to be high. It seems what you are imagining is just that–pure imagination. For as long as I’ve been alive (and much longer) we have been able to walk into a store and offer a piece of paper to a stranger with the name of a bank that they’ve never heard of and some numbers that mean nothing to them and exchange it for goods. Now we have cards that we swipe and computers tell us that this represents a legitimate transfer of money. These things hardly have brought our economy to a standstill because of uncertainty about the validity of the payment. Neither have these innovations been the result of government meddling in the economy, they come about because if you can find a better way to carry out transactions there are mutual benefits created and you can usually capture some of them. Often this requires reputation to work but in this case you can make money by building and maintaining a reputation. There is really no reason to think that if the government left us alone we would suddenly find it stupendously difficult to make transactions. If you are determined to make up reasons why this might happen and go to no effort to imagine how millions of smart enterprising individuals working to make a profit by solving them might be able to then I’m sure you will remain terrified by freedom but history doesn’t warrant such a sentiment.

    Yes they would charge for their services. This is how free markets work. They work because what they provide is worth more than what they charge (and costs less). Mutual benefits. But nobody has to “create” currency, if gold is the most efficient form of currency it will be used simply by virtue of being the most efficient. What people will create is ways of economizing on exchange. When the government tells you they are going to give you something for free that the market charges for it isn’t really free it just means they are concealing the real cost from you. In this case it is a very serious cost.

    No, banks are not “free” now, they are subject to the coercive powers of a centralized banking cartel that is backed by the government. Furthermore the government tells us we have to accept the dollars that they (the Fed) pring for our goods and services and discharge of debts and it tells us we can’t do things like create a gold bank (I think Peter Schiff is doing this but had to take it offshore). You “liberals” are always complaining about big business conspiring against the public. Why don’t you seem to care when bankers, the biggest most evil businesses of all (not my sentiment FTR), are actually granted the full force of the federal government to enforce their cartel? If you were really “liberal” in the sense that you valued individual liberty, wouldn’t you be offended by this even if you thought it might make GDP a little higher?

  9. Free Radical
    October 5, 2011 at 10:22 pm

    5. I didn’t say you shouldn’t have rules about polluting other people’s water I just said you would have clean water. This is because water is something that it is possible to capture physically and transfer. This doesn’t mean there is no potential for externalities but if the price of water were high enough someone would find a way to provide it I guarantee. Similaryl if the price of information were high enough someone would find a way to provide it. You keep talking about information costs as though they will destroy every market but there are plenty of organizations we have observed that deal in this type of information, not to mention reputations of sellers and long-term relationships. It’s easy to wave you hand and say that a market might not be perfectly efficient with costly information but you are drastically exaggerating the extent of the damage.

    You insist on saying that people won’t do what is best for them if the government doesn’t make them. If this is your justification for government running our lives there is really no point in us talking to each other. In fact I will wait before responding to your other points until you adress this. There is no reason that people can’t handle this themselves. You say they won’t and maybe they won’t but if you are doing economics responsibly you can only interpret this to mean that they don’t want to. If they don’t want to where do you get off forcing them to? If you just think the government knows what’s best for us better than we do and this gives them to right to control our lives you just don’t value individual liberty so I can’t help you, no argument about the economic effects of anything will make a difference to you.

    Liberals don’t literally say nothing will get done without government doing it but in nearly every situation where they disagree with me it is because they are implicitly assuming that the thing they are talking about won’t get done unless government does it. That is what you are doing here, it is incorrect, and you are splitting hairs by arguing with my way of saying it.

    You’re making another common leftist mistake, you are saying we need to do two contradictory things “the will of the majority” and the “rights of the minority.” You can only have one. Leftists say things like this to avoid recognizing that there is a tradeoff. Either the government can take my property against my will without due process because the majority thinks they should or they can’t. It’s not subtle, you just have to open your eyes and see it for what it is and choose one.

    You’re completely wrong about medical care. You just keep making the same mistake assuming that if people don’t know everything the whole market will collapse, I can’t argue with you any more about it in every market where you think this will happen. The problems we have with healthcare now are almost entirely caused by the government. I’m sure you won’t believe me so I think I’m giving up for now….

  10. Free Radical
    October 10, 2011 at 10:50 pm

    6. It’s quite possible I made an arithmetic error, I will go look at it but even if I did it is basically unrelated to your criticism. You are saying “if the real rate is x and the expected inflation/deflation is y, then there is no real rate that works.” But that’s not the right way to think about it. A better way would be to ask, if the real rate were x and the expected inflation/deflation rate were y, then what would the nominal rate be? The nominal rate is the “flex” rate, so to speak, in a free market economy. The real rate is determined by time preference and production opportunities, the inflation rate is determined by the exogenous money supply, (obviously in relation to the later) and the nominal rate is the thing that adjusts to account for the risk premium. This is the whole reason most people have trouble understanding it because you insist on treating the nominal rate as exogenous. But it’s only exogenouse in the sense that the Fed chooses it. It is the fact that the Fed has decided to choose nominal rates that the whole thing doesn’t work. If you are talking about a market you can’t say with regard to prices (and endogenous variable) that if one price were x and another were y, there is no third price which would bring the market into equilibrium. If this is the case why are the first two prices x and y????

    7. Freedom has nothing to do with the “economic consequences that result” and the Janis Joplin line is completely irrelivant. Freedom is what it is, the ability to do what you want. This in no way requires you to have nothing to lose. That’s just more nonsense that the left uses to convince you that freedom is really about the stuff you have or don’t have. I know you’re not going to agree with my economics as long as it is possible to convince yourself that it might be wrong so I have little energy left to argue with you about every possible market that you think will fail if people are too free. The only effect I think I could possibly have on someone like you is just to get you to realize what you are choosing between. Government is defined by its ability to force people to do things against their will. This is the point of it. But the ability to do this, if well controlled, is necessary for any sort of functioning society because it greatly enhances property rights and the ability to enter into mutually voluntary contracts. But this is all that it needs to do–delineate property rights. Half of your examples of why government needs to intervene in markets are really just ways of saying it needs to delineate property rights and those I agree with. The others are ways of saying that it is somehow better for the government to choose winners and losers and redistribute wealth and make everyone “equal” or something and that it is ok as long as a majority agree with it. This I don’t agree with because it is diametrically opposed to the notion of individual liberty. The government has to collect taxes to function but the taxes should be layed out in a simple way that doesn’t allow them to favor some people over others. Coincidentally this is how they were designed originally (at least to a large extent, there was still some potential to favor certain industries but this kind of class warfare and general social engineering was constitutionally prohibited). I just want you to admit to yourself that you have to sacrifice individual liberty to do these things because they are always going to want a little more and they will always say it is in the name of equality and social justice and fairness etc. and you will say “ok” because you will be deceiving yourself into thinking that you’re not really trading freedom for these things but that you are actually getting freedom. Just admit what you are advocating and stand by it. At least that way you will be aware of what you are doing.

    P.S. what you are calling a “collective action problem” is really just other people not wanting the same thing you want. This is another leftist way of helping you avoid the reality that what you are really doing is forcing your values on others who do not share them. Pleas just admit to yourself that that’s what you are doing and if you’re fine with it then choose it willingly.

  11. Free Radical
    October 11, 2011 at 4:31 am

    P.S. In number 6 it is deflation every time, I’m not sure why you are saying it was inflation when it was 6% and deflation when it was 8%. I am also quite confident from your comments that you are not getting the point of that post. I don’t think you are trying to though I think you are convinced it must be wrong and are just looking for something to argue with.

    • February 4, 2013 at 1:54 am

      StagflationUltimately the gov can steer the ship in any direction it wants, and initolfan is the only politically easy way to defuse the debt bomb.IMO fed is likely to cut 25 bp Sept 18. This is a freebie because FF is already trading at 5% anyway. Any cut that’s bigger or sooner sends the wrong signal. I mean, all the passengers on the plane can look out the window and see the engines are on fire. 25 bp on Sept. 18 will feel like the pilot is still trying to fly the aircraft in for some kind of landing. 50 bp prior to Sept. 18 will feel like you see him setting the autopilot while strapping on a chute.I’m looking for some major non-Fed action to try to reduce the bleeding. Conforming limit bump would help improve liquidity and is OK with me provided credit standards are still high. That will help creditworthy current owners refi and creditworthy borrowers buy RE if they want to. I expect some sort of giant patch for the rest. Gov will go to the lenders and triage the FBs – there are some who could and would keep servicing the debt despite being upside-down, if only they could get a fixed-rate mortgage at a rate that is not usurous. Some sort of loan guarantee program will be rolled out to make it happen. Gov doesn’t even need to hold a gun to the lender’s head, because they are already holding guns to their own heads and begging someone to stop them from pulling the trigger.The observation about the likely effect of declining rates on bank deposits is one I had not considered but rings true. I was burned when Easy Al took rates down to 1%, heck even at 5% I’m losing money to initolfan after taxes. For damned sure I’m not going to just lie back and take it again – I’ll buy stocks, gold, even RE if I have to. So, like, yeah, cuts down to Japanese interest rates don’t seem to be in the cards this time around.Gov needs to do something to encourage savers, instead we will likely have a Democrat anxious to “soak the rich” with even higher taxes eating into the already-negative real returns on bank deposits. I really feel like a chump when I think about it.

  12. attilalendvai
    May 4, 2012 at 12:51 am

    i’ve pointed out a few opaque things in this discussion of fb:

    in short:

    – the independence of the FED, and the constraint it has on the USgov, is a textbook illusion. e.g it bought 60+% of the USgov debt issued in 2011…

    – “The rates could be allowed to increase as much as was required to arrest inflation” — i think this assumption ignores several issues rising interest rates introduce…

    – falling interest rates (or in general the high amplitude of changing interest rate enforced by coercion), erodes capital. which then slowly bankrupts the productive layer of society and shift decision making from the people who produce what others want to have (IOW welfare, wealth) towards parasites who using their coercive power consume without producing. this then shrinks their host (the economy formed by the productive people), and moves society back towards its natural state: people hunting and gathering. because poverty is the norm and wealth is the magic, which can be achieved by human cooperation, trade and competition of ideas… removing/damaging the positive feedback loop on production will erode wealth.

    more detailed thoughts in the discussion i linked to, including links to data.

    • Free Radical
      May 7, 2012 at 6:00 pm

      I don’t think you understand what I am trying to do here. I’m not supporting the institution, I’m explaining why Austrians are wrong about the way it will fail (it will be even worse). You’re giving me arguments against the Fed which I mostly agree with but are essentially unrelated to the argument I’m making here.

  13. attilalendvai
    May 4, 2012 at 1:19 am

    Further, if you look at the economy during the 19th century, when we had a system which I think was fairly close to what the Austrians–and I think you–promote, we had a series of booms and busts, with a recession (or depression) happening every couple of years.

    1) i suggest you to not focus on “recession”, “depression” and other charged words that change meaning with a high pace (which are merely concepts in our minds that don’t exist in material reality), and try to look at the quality of life in those periods instead (focus on the material reality).

    it’s very hard to compare a recession in a fiat monetary system to a recession in a monetary system that involves no or way much less coercion. and especially so if we call both units of accounts the same (dollar), even though the first and second derivative of their value behaved very different, and they also meant completely different things (some amount of precious metal, as opposed to a claim on the future taxing power of the strongest residing enforcement organization).

    2) regular small boom/bust cycles (a few years) are much better than rare but magnificent booms/busts because they devastate the entire society, while the regular ones are merely the adjustment of the people (the economy) to external changes, mostly to the changes in technology helping production and/or organizing society.

    i guess you read the austrian perspective on credit expansion… but: http://mises.org/daily/5938/Seventeen-Years-of-Boom-and-Bust

  14. attilalendvai
    May 7, 2012 at 7:47 pm

    i meant “incoherent” regarding the comments. sorry for not being clear enough about that…

    • Free Radical
      May 8, 2012 at 2:13 am

      Ahhh I see, in that case you may be right, haha.

  15. February 6, 2013 at 8:35 am

    “The fundamentals of the US ecoomny are shot.”this is where I disagree and think that John McCain is tell the truth since America has the courage to make hard economic transitions;that’s something that socialist countries refuse to do. personally, I think we won, economically, in Iraq and our military technology is only growing stronger.Moreover, Sigmond Freud once wrote that “Jews have always had the edge since they’re militant although they’ve had their ups and downs; howerver, cultures who have sided with them have benefited.”So you can’t count out the US.The problem is that Schiff isn’t necessarily wrong since prices are controlled and the banks can take dollars away by letting the price of Gold go up so it crash and the bankers can buy it back for nothing.So I think it’s a game.I personally think that “trickle down economics” is a historical driving force since we all inherit the fruits of our forefathers’ efforts and America, for better or worse, stood behind globalization and I think that the economic result of that is beyond imagination.For example, the kind of collaborations I’ve seen on the internet are beyond marvelous.The housing crash, and the like, seem like circus acts which merely entertain the peons.Of course, I wish that “resource extraction” could be environmentally friendly; it’s not so perhaps one day we’ll all pay! until then, materialism will rule.

  1. December 20, 2011 at 2:37 am

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