All Fiat Money Systems Fail, Right? Wrong.

[Pointedstick]

\So they are on the path to blowing up their currency again. But what will it blamed on this time from macro perspective? Can't blame gold. Can't blame currency pegs. Can't blame foreign demons. It is solely the responsibility of the people running the government and money. That's it. There is no macroeconomic excuse for it this time. The micro level details of corruption make the macro level solutions unworkable.

I don't think anyone here will argue with you that Argentina's problems are caused by anything but terrible governance. Rather, I think our point is that that had Argentina been on a self-imposed gold standard, little would be different today because their horrible corrupt government would have either found ways around its restrictions or ditched it entirely, like nearly all other nations have.

[Gumby]

So they are on the path to blowing up their currency again. But what will it blamed on this time from macro perspective? Can't blame gold. Can't blame currency pegs. Can't blame foreign demons. It is solely the responsibility of the people running the government and money. That's it. There is no macroeconomic excuse for it this time.

First of all, Argentina has massive amounts of foreign denominated debt.

http://blogs.ft.com/beyond-brics/2012/0 ... z2BjJckO5I

They owe enormous amounts of debt in a currency they can't print more of. It's a huge Macro issue that you brush under the rug simply because you don't want to talk about it. The fact that the IMF is pressuring Argentina in the first place is in and of itself a testament to their massive foreign-denominated debt. We all agree that Argentina is crashing its own car, which is something that can happen to any monetary system. But it wouldn't make a difference if they were on fiat or gold. If they were on a gold standard, they'd just be experiencing massive forced austerity (like Greece) for all their borrowing and they'd be looking for ways to unpeg from gold.

Second, this idea that putting a country on a gold standard prevents them from making bad decisions is pure fantasy. A government just stops pegging their currency to gold when it becomes inconvenient to them — which is exactly what happened in every country on the planet. Countries left the gold standard for MACRO reasons (see Einstein's macro explanation above).

ALL monetary systems can be destroyed by bad government decisions.

The gold standard is no panacea since it causes major macro issues for trade-deficit nations.

[moda0306]

Uh oh... follow up article on why a Gold standard isn't synonymous with freedom:

http://pragcap.com/the-gold-standard-is ... th-freedom

Also, this lack of belief by some conservatives that there is really anything different about "macro"-economics is mind-boggling.  While Craig has the humility and forsight to invest in the PP, most peoples' misunderstandings about macro=micro have lost them a lot of money over the last few years, assuming runaway inflation and/or interest rates.

I liken it to this: A lot of businessmen went through a period in their lives where they worked their @sses off and ate Ramen noodles while renting out a basement bedroom of their buddies too-big house, putting tons of time, sweat blood and tears into their productive venture until it finally took off.  While their buddies were going to happy-hours, they were honing their craft or working late, probably also trying to pay down their college debt as fast as possible.  They voluntarily sacrificed in ways few in this country will ever really understand.  Rightly, they have an attitude that Americans should toughen up and quit whining about needing this, that or the other thing.  However, what they don't realize, is all the money they used to pay off their debt, all the money they earned trying to bring a product/service to the public, is as a result of somebody else SPENDING their money.  We have to have some equilibrium between supply and demand on a macro level for the Steve Jobs of the world to be able to sustain themselves while building the next Apple.  Further, quite simply, one person's liability is another's asset.  One person's expense is another's income.  Entreprenurial ventures require not only the cash-flow to keep Steve Jobs fed, clothed, and sane in the mean-time, but demand, or likely future demand, for the product/service you're trying to bring to market.  Not everyone can slash spending at the same time without the entrepreneurs of this world paying a horrible price.  THAT is macro vs micro.  Any one person can go the Ramentrepreneur route, but if too many people start doing that it becomes a logical fallacy.  We can't all become producers without consumers, and not just at some nebulous future time, but consuming soon and fast enough to keep entrepreneurs afloat while they improve their businesses.  For everything produced there must be a consumer, on a MACRO level.

Craig, is there something inaccurate about that example?  We don't have to agree on every aspect of macroeconomics to realize that some things work very different when you pull back and look at the moving pieces as a whole than if you simply try to focus on one of the moving pieces and extrapolate that to the whole.

I think you know where I'm going with that last statement !

[Gumby]

Uh oh... follow up article on why a Gold standard isn't synonymous with freedom:

http://pragcap.com/the-gold-standard-is ... th-freedom

Interesting perspective. For those who didn't click...

A lot of people didn’t like my recent article about fiat money.  That was to be expected.  And the usual arguments were trotted out.  The old “it takes two people to support a family”?.  And then the “fiat is synonymous with corrupt governments”?.  First of all, those statements aren’t totally false.  But let me elaborate.

If you really wanted to live like you’re in the 1950's you could most likely survive very easily on one salary.  Try this.  Get rid of your McMansion and move into a cottage with no AC, no heat, no microwave, etc.  (okay, that’s extreme, but you get the point hopefully – we live in suped up houses these days where the technologies are far superior to those of the 50s).  Then massively downsize your home and add an extra occupant.  Then get rid of your flat screen TVs, cell phones, cars, computers and technological items that you love.  Okay, some of that is unnecessary, but you get the point.  The reason why we need two salaries to survive in today’s world is because we demand that much more from our lives.  We want all the best toys, the best educations, the best roof over our head.  These things aren’t free obviously.  And as a result of two working heads of household, we are able to provide much better living standards to our families than we did in 1950.  Don’t trust me?  Seriously, live the 1950's lifestyle and let me know if you can get by.  You probably won’t last a week.

The other common retort is that gold standards are somehow synonymous with freedom because they reduce the government’s ability to manipulate the money supply.  Okay, that’s true to some degree.  But this also misses another important point about the gold standard.  The quantity and value of gold in today’s world is largely determined by foreign governments and guys with shovels.  In other words, its value and quantity is mostly determined by a small group of people incentivized to corrupt its value.  We read endless stories these days about how Chinese and Indian central bankers are buying gold or digging it out of the ground.  Is that “freedom”? for the USA?  Is it wise for the USA’s money supply to be essentially pegged to dictators or foreigners digging the earth up?  Yes, we will put the US government in check, but why don’t we just let foreigners run the whole damn US economy while we’re at it since they’re going to be determining our money supply indirectly.  And this doesn’t even touch on the gold standard’s primary flaw which is the natural trade imbalances that will result from it….Freedom?  Not even close.  This is more like voluntarily gagging yourself, wearing a straight jacket and begging everyone to beat you with a baseball bat.

Fiat money is not perfect by any means.  And if the government is allowed to corrupt it then the system will surely fail.  But the power of the American system lies not in fiat, but in the fact that the people determine the government thereby determining whether the government is corrupt.  And more importantly, it is the people who ultimately determine the value of the currency via their ability to produce output that makes this tool of exchange valuable in the first place.  This is why it’s so important to actually understand the market based design of our monetary system.  The quantity of money is not determined by the central bank or by the government (or at least only very loosely).  It is primarily determined by the market place via the quantity of loans that are made based on the demand for credit (we reside in a credit based money system where almost all money exists in the form of bank deposits that result from loans issued by private banks on a demand basis).  If anything, it is the market that determines the quantity of money in the US economy via the private banking system and competitive market based system for loan issuance.

In the right type of system, fiat money is perfectly synonymous with freedom.

Source: http://pragcap.com/the-gold-standard-is ... th-freedom

[Gumby]

I liken it to this: A lot of businessmen went through a period in their lives where they worked their @sses off and ate Ramen noodles while renting out a basement bedroom of their buddies too-big house,...However, what they don't realize, is all the money they used to pay off their debt, all the money they earned trying to bring a product/service to the public, is as a result of somebody else SPENDING their money...Further, quite simply, one person's liability is another's asset.

Yes! When someone becomes rich or earns a salary, they have actually earned others debt or credit spending (since our money supply comes from either public or private debt). It's hard to see that if you don't look at Macro.

Ironically, many individuals become wealthy in a fiat system and simultaneously wish it were a gold standard system — perhaps as a desire to preserve their hard earned wealth.

[moda0306]

Yup... "Suppliers" require a steady stream of demand.  Our entire economy can't just eat Ramen, pay down debt, work 60 hours per week, and save 50% of their income.

[Pointedstick]

Yup... "Suppliers" require a steady stream of demand.  Our entire economy can't just eat Ramen, pay down debt, work 60 hours per week, and save 50% of their income.

At least not without shrinking, it can't. If everyone rode bicycles, that would probably kill off the car industry, but it would free up capital, materials, and labor for the bicycle industry. Even people working out of their friends' basements and saving 50% of their salary need to buy some things. If everyone did this, then on one hand we'd have a smaller, less powerful economy, but on the other hand we'd have a very resilient population.

[moda0306]

PS,

Yes, what you're talking about are structural shifts in the economy, and those are completely valid.  Our economy can't just turn on a dime, and we shouldn't suffer massive inflation just to keep dying industries alive and people effectively in make-work jobs.  The big question is, whether our current recession is as a result of a structural shift of what people really want, or just an economic Mexican standoff due to a monetized economy (when all productive and/or payment contracts are denominated in a single unit, it creates efficiency, but also fragility).

I think it's both.  We want less housing, more healthcare, etc... but we also have a lot of people not working simply because their customers are unemployed or underemployed.

[moda0306]

Countries can be a macro/micro mix, but for the most part, people tend to buy and sell mostly within their country.  Especially for big countries, there is less and less micro to it all...

[melveyr]

Example of micro versus macro...

In a micro model spent money disappears. It's as if money is consumed.
A macro model tracks takes a stock flow consistent approach, seeing spending as a flow and then it tabulating where it accumulates as a stock.

Micro is basically just a simplification, a departure from reality, which is okay for small scale problems. Citizens and businessmen often look at things with a micro approach because as far as they are concerned, they can consider spent money consumed, burnt up. This simplification is good enough when managing your own finances, but is entirely flawed when trying to analyze an economy.

Economics makes way more sense if you take the time to understand what a stock is versus a flow. Everything clicks. You will also be much better at understanding income statements and balance sheets. Additionally, you will have a better understanding of so many financial metrics because you identify if they are a flow/flow measurement, stock/stock measurement, or flow/stock measurement.

[Tortoise]

Example of micro versus macro...

In a micro model spent money disappears. It's as if money is consumed.
A macro model tracks takes a stock flow consistent approach, seeing spending as a flow and then it tabulating where it accumulates as a stock.

I've never seen micro presented that way. In micro, spent cash is simply traded for various goods and services. The cash doesn't disappear, it just changes hands. Am I missing something?

Maybe you could provide a simple example of what you're referring to.

[Pointedstick]

It may change hands, but you don't care about it anymore. From your micro personal/household point of view, your money is no longer available. You don't care if it went to the government, a private corporation, or the incinerator. The macro perspective is what cares about where the money goes once it changes hands.

[moda0306]

Tortoise,

What melveyr's saying is that on a micro-level, we're looking at one player in the market place.  For instance, when a household spends money, it loses that money forever, but gains cereal, a flat tv, a new roof, or whatever.  Yes, we know it's in someone else's hands, but that's irrelevant to the household... they have less money, and might miss a mortgage payment because of it.

That's why in micro systems, the entity can "run out of money," but in macro-systems, it's always simply changing hands.

[Tortoise]

Okay, so you guys seem to be arguing that microeconomics is effectively "me economics." I.e., economics that only looks at one side of every transaction--the "me" side.

I disagree. In microeconomics it's definitely acknowledged that there are two sides to every transaction. It's just that micro looks at individual transactions or small groups of transactions in isolation rather than entire systems consisting of millions or billions of transactions.

Am I still missing something?

[moda0306]

To me, microeconomics has always been about making decisions as a player in a game where the game doesn't change as a result of you making decisions.  For instance, I have to decide how many widgets to make or how many people to hire, and I'll use supply/demand curves, elasticity assumptions, etc, to decide what decisions to make, knowing that by making decision A or decision B I'm not actually changing the nature of the market I play in, but just adjusting to the conditions.

Macroeconomics involves positive and negative feedback loops because when you decide to fire people, halt widget production, or change the price of widgets, it actually affects the market, sometimes significiantly.  For instance, if the government were to say "holy $hit we can't afford to spend money now," the government would quit paying half social security and fire a bunch of employees.  Except, that actually affects tax revenue, so now they've not improved their budget to the degree they thought they would.

Only macro recognizes these feedback loops.  I'd also argue only macro truly realizes the ramifications of all expenses being someone elses income, and all debt being someone else's asset, and how flows all interplay amongst the system as a whole.

It's like the difference between particle physics and neutonian physics... they simply work on different levels.

[melveyr]

Okay, so you guys seem to be arguing that microeconomics is effectively "me economics." I.e., economics that only looks at one side of every transaction--the "me" side.

I disagree. In microeconomics it's definitely acknowledged that there are two sides to every transaction. It's just that micro looks at individual transactions or small groups of transactions in isolation rather than entire systems consisting of millions or billions of transactions.

Am I still missing something?

Edit: Ahh moda beat me 

Microeconomists are certainly not dumb; I didn't mean to imply that. They know that one firms spending is another persons income. But for the problems they are trying to explain that truth is largely irrelevant. They are not trying to develop a general framework for understanding an economy, they will happily point you to a macroeconomist for that. They use their tools for understanding monopolies, profit, maximization, subsidies, elasticities for different goods... things like that. Their models do not account for where money goes and accumulates because it is irrelevant to their problem.

If you were hired by Microsoft to help them understand how to maximize their profits, would you care what effect their different actions would have on aggregate GDP? Probably not. Would you try to track where dollars go after they leave the firms coffers? Probably not.

A good microeconomists understands the limitations of their models, and they are the first to tell you that. Adding up individual microeconomic outcomes predicted by these models to arrive at a macro answer is not a good idea. Both micro and macro professionals agree on this.

[Gumby]

melveyr, saw your exchange with Cullen today. Sounds like he's a fan of yours! Pretty cool.

Guess we need to start calling Monetary Realism by its proper abbreviation — MR (not MMR).

[melveyr]

melveyr, saw your exchange with Cullen today. Sounds like he's a fan of yours! Pretty cool.

Guess we need to start calling Monetary Realism by its proper abbreviation — MR (not MMR).

Yeah Cullen seems like an all around nice guy 

I still must say that I do appreciate MMT as well as MR. Gumby, you should consider Randall Wray's new book. It's very good. He actually is more explicit about separating prescriptive from descriptive than he used to be.

[AgAuMoney]

Is it just me, or is that article junk?

Total junk.

The guy has zero grasp of monetary history.

I suspect he was writing articles in about 1999 telling us that stocks with P.E. of 100, 200, or even infinite (because they had no earnings, but would soon) were great investments.  Forget the old days, this is the information age, baby!

[AgAuMoney]

But, seriously, craig. Don't you see that gold-backed paper currency would become just as worthless as fiat paper money when a government failed? In both cases their value is linked to a particular government existing.

A "gold standard" isn't just gold-backed paper.

A "gold standard" says you can return that paper to the issuer for a guaranteed amount of gold.  If you let the issue die leaving you holding paper, that's your fault.  You kept the paper for convenience, and you paid the price.

That exchange requirement is why 1933 to 1971 the U.S. was on the "vestiges" of the gold standard.  The only redeemable guarantee was for foreign central banks.  Same problem, those that kept the paper until problems were obvious paid for that convenience.  Just trying getting gold for $35 an ounce or even $42.22 an ounce in 1972 or any time since.

[AgAuMoney]

But we can prove that gold-backed currency fails when a government fails.

No you can't.  You can only prove that gov't promises fail.  The paper, fiat, failed.  Keep your savings in the gold coins, keep paper in your pocket.  Your money will be fine when the gov't fails.

[AgAuMoney]

Well you know I can show you that some people drive drunk all the time and never get into an accident. But that doesn't mean driving drunk is a good idea.

Comparatively speaking, gold standards are better than pure fiat. Even ignoring the conversion issue which can always be a problem, it tends t exhibit more control on government and that means less chance that government is going to have fiscal problems that cause it to go bye-bye.

That seems sort of like a cop-out. Governments on a gold standard always suspend it during times of great perceived need for monetary expansion and spending. The gold standard sure didn't prevent the North from spending tons of cash during the Civil War, or the USA from doing the same in the world wars, especially the second, which was ridiculously expensive. If the gold standard is supposed to prevent things like this from happening, then it did a poor job if it was so easily swept aside with the stroke of a pen.

The civil war printed money and they traded at a discount.  They didn't suspend the gold standard.  It was painful to cover all those 'greenbacks' but they managed.

The WW-I nearly broke the gold standard.  But it didn't for the U.S.  The U.S. borrowed the money and repaid it.

By WW-II the U.S. was no longer on the gold standard.  The only ones who could hold us accountable were foreign banks.  By the mid-1960's they were.  And that caused the end of the last vestiges of the gold standard, because gov't promises were broken.

The point is, that with a gold standard you have a promise that is good until it isn't.  With fiat you don't even have that.

[AgAuMoney]

I love that graph.  It shows how much more damaging deflation is than inflation in terms of a nations ability to create and market wealth & production.

That graph is meaningless garbage.

Of course GDP goes down during deflation.  GDP is a measure of prices!  That doesn't mean that productivity declined.  You have no idea.

Now if you see GDP go down during inflation you KNOW there is a real problem.

Deflation is in general very good for everyone except debtors.  I bet you like the past 50 years of deflation in electronics, or even just the last 10 years deflation in HD flat-panel televisions.

[AgAuMoney]

Believe me, macro issues are all micro issues.

Craig,

I think I finally get where you are coming from. I didn't realize that you hadn't learned about macroeconomics. The entire reason economics is split into two areas is because the above quote is wrong.

That extract is wrongly taken out of context.

But what he was talking about with the bribes, et al. are a micro problem that causes problems in the macro economy.  It isn't a problem in micro economics vs macro economics.  It is a problem with rule of law.

[Pointedstick]

A "gold standard" isn't just gold-backed paper.

A "gold standard" says you can return that paper to the issuer for a guaranteed amount of gold.

Isn't that just another government promise? How is the promise of redeemability any more trustworthy than the promise of continued value that backs a fiat currency? Actual gold coins are one thing, but gold-backed paper (which is what most people keep 99% of their assets in under a gold standard anyway) entails just as much of a promise as a fiat currency, no?

Doesn't the fact that every government on the gold standard broke the redeemability promise during their move to a pure fiat currency explode the idea of that promise holding any more value than the promise underpinning the fiat currency they moved to?