WEBVTT NOTE Money and Its Purchasing Power 1 00:00:00.000 --> 00:00:10.100 Okay, for most of my chapter, or rather for the part of the chapter on the purchasing power of money that I'm going to cover, 2 00:00:10.100 --> 00:00:14.500 Rothbard uses the assumption of neutral money. 3 00:00:14.500 --> 00:00:24.100 That is, that when there's a change in the money supply, it changes prices proportionally and therefore has no effect, and instantaneously, 4 00:00:24.100 --> 00:00:28.000 and therefore has no effect on the real economy. 5 00:00:28.000 --> 00:00:32.040 That is, that neutral money assumption is a working assumption. 6 00:00:32.040 --> 00:00:37.640 He doesn't believe, as neoclassical economists do today, as all macroeconomists do today, 7 00:00:37.640 --> 00:00:45.360 that in the long run, money is actually neutral after all of the short-run, interim effects work themselves out. 8 00:00:45.360 --> 00:00:51.600 But for the problems that he wants to analyze, neutral money is a very important assumption. 9 00:00:51.600 --> 00:00:58.080 Later on, in the part of the chapter that Professor Herbiner is covering, that assumption will be dropped. 10 00:00:58.080 --> 00:01:02.880 Now Rothbard has been criticized because people look at the first part of the chapter 11 00:01:02.880 --> 00:01:06.560 and they say, well, this is a very equilibrium analysis of money. 12 00:01:06.560 --> 00:01:12.800 But there are certain problems in monetary theory, certain important problems that have to be analyzed 13 00:01:12.800 --> 00:01:16.480 using an equilibrium construct of some kind. 14 00:01:16.480 --> 00:01:20.580 or to put it another way, forgetting about the intermediate effects 15 00:01:20.580 --> 00:01:27.780 that link the initial change to the final outcome. 16 00:01:27.780 --> 00:01:30.080 So we're going to suppress these initial effects 17 00:01:30.080 --> 00:01:35.880 and we're going to focus on what I think is a key diagram in monetary theory 18 00:01:35.880 --> 00:01:39.780 and this is the supply and demand for money. 19 00:01:39.780 --> 00:01:43.480 This diagram, believe it or not, I actually adapted it 20 00:01:43.480 --> 00:01:47.480 from the principal's text by N. Gregory Mankiw, 21 00:01:47.480 --> 00:01:53.480 who is one of the top macroeconomists writing in the U.S. today. 22 00:01:53.480 --> 00:02:00.480 Rothbard was probably one of the first people to have this diagram in the history of economic thought. 23 00:02:00.480 --> 00:02:04.480 Edwin Cannon in the 1920s wrote a book in which he verbally described this diagram, 24 00:02:04.480 --> 00:02:10.480 in which the demand for money was inversely related to the purchasing power of money. 25 00:02:10.480 --> 00:02:12.480 I'll explain that in a moment. 26 00:02:12.480 --> 00:02:18.920 Then later on, Rothbard had told me that after he wrote Man Economy and State, 27 00:02:18.920 --> 00:02:28.160 he realized that Richard Timberlake had a similar diagram in his textbook on money. 28 00:02:28.160 --> 00:02:31.360 But that very few others have used this diagram. 29 00:02:31.360 --> 00:02:36.120 So I was surprised in the principal's text that I used, Mankiw, that this diagram would appear. 30 00:02:36.120 --> 00:02:40.440 Now in his intermediate macroeconomics text, this is not there. 31 00:02:40.440 --> 00:02:48.040 He uses the straightforward quantity theory to explain the law and effects on the price level of a change in the money supply. 32 00:02:48.040 --> 00:02:57.540 And in the short run he uses the standard Keynesian liquidity preference diagram in which the demand for money is inversely related to the interest rate. 33 00:02:57.540 --> 00:03:00.940 So it's very interesting that he uses this introductory text. 34 00:03:00.940 --> 00:03:08.940 He then later on supplements it with the quantity theory of money or the quantity equation of Fisher. 35 00:03:10.440 --> 00:03:20.440 Now, Mankiw's diagram differs from Rothbard's in one respect, and it's a heuristic device, and I think it clarifies matters quite a bit. 36 00:03:20.440 --> 00:03:29.440 On the left y-axis, we have the purchasing power of money, and by the way, since we're making a neutral money assumption, 37 00:03:29.440 --> 00:03:39.440 we can take any good and use its price as a proxy for the price level, because all prices change proportionally when the money supply changes. 38 00:03:39.440 --> 00:03:47.440 Not quite proportionally, but we can suppress these sort of, as I said, intermediate distribution effects. 39 00:03:47.440 --> 00:03:53.440 In any case, the purchasing power of money is increasing as we move upward on the left side. 40 00:03:53.440 --> 00:03:59.440 I've used yogurt cones, Mancu uses pizza sometimes, sometimes he uses ice cream cones. 41 00:03:59.440 --> 00:04:01.440 I think one edition was different from the next edition. 42 00:04:01.440 --> 00:04:08.440 In any case, what that tells us is at point E, the equilibrium point for a moment, I'll explain that later, 43 00:04:08.440 --> 00:04:13.640 The equilibrium purchasing power of money is one yogurt cone. 44 00:04:13.640 --> 00:04:16.640 A dollar can purchase one yogurt cone. 45 00:04:16.640 --> 00:04:21.440 Now the reason being on the right axis is because we have the prices of yogurt cones. 46 00:04:21.440 --> 00:04:27.640 Now prices are increasing in a downward direction, thus the downward arrow. 47 00:04:27.640 --> 00:04:31.940 So that as the price of a yogurt cone is one dollar, 48 00:04:31.940 --> 00:04:37.440 well then the purchasing power of money is one over one dollar or one yogurt cone. 49 00:04:37.440 --> 00:04:44.280 As the price level rises, I was going to say as we have inflation, 50 00:04:44.280 --> 00:04:46.480 but it doesn't have to rise because of monetary inflation alone, 51 00:04:46.480 --> 00:04:49.600 but if we do have a monetary inflation, price is double, 52 00:04:49.600 --> 00:04:51.920 yogurt cones go from a dollar to two dollars, 53 00:04:51.920 --> 00:04:55.480 then the purchasing power of the dollar shrinks. 54 00:04:55.480 --> 00:05:00.480 That is, it can now purchase one over two or one half a yogurt cone. 55 00:05:00.480 --> 00:05:04.800 On the other hand, a fall or an appreciation in the value of money, 56 00:05:04.800 --> 00:05:12.240 which is a fall in prices, results in an increase in the purchasing power to two yogurt cones 57 00:05:12.240 --> 00:05:16.640 which corresponds to a price of 50 cents per yogurt cone. 58 00:05:16.640 --> 00:05:23.640 Okay, so I think relating prices to the purchasing power money in that way makes things a lot clearer. 59 00:05:23.640 --> 00:05:30.520 So Rothbard starts by pointing out that like all commodities, money, which is also a commodity, 60 00:05:30.520 --> 00:05:37.120 has its own supply and demand and its own price. 61 00:05:37.120 --> 00:05:42.420 One monetary economist once said that all errors relating to money 62 00:05:42.420 --> 00:05:49.020 stem from the view that money is either more than or less than a commodity. 63 00:05:49.020 --> 00:05:51.420 For Rothbard, money is a commodity. 64 00:05:51.420 --> 00:05:57.820 It's the most generally accepted or marketable or saleable commodity in the economy. 65 00:05:57.820 --> 00:06:03.820 So, all commodities have supply and demand, which determines their price. 66 00:06:03.820 --> 00:06:08.180 The difference between the monetary price or the price of money and all the prices 67 00:06:08.180 --> 00:06:12.620 is that money is still in a state of border with respect to the rest of the economy. 68 00:06:12.620 --> 00:06:15.620 Money is one half of every transaction. 69 00:06:15.620 --> 00:06:23.220 Therefore, money has a price in every single good traded in a monetary economy. 70 00:06:23.220 --> 00:06:31.220 So, money's price isn't a single price, though it can be represented as such under a regime of neutral money, 71 00:06:31.220 --> 00:06:36.220 or under the assumption of neutral money. It's an array of prices. 72 00:06:36.220 --> 00:06:43.220 It's the alternative quantities of other goods and services that can be purchased in exchange for money. 73 00:06:43.220 --> 00:06:52.220 So the purchasing power of money is either one yogurt cone, or one one-thousandth of an LCD, high definition LCD television, 74 00:06:52.220 --> 00:07:00.220 or one-twenty-thousandth of an automobile, or one-fifth of a McDonald's hamburger, and so on. 75 00:07:00.220 --> 00:07:04.220 So it's a whole array of alternative quantities. 76 00:07:04.220 --> 00:07:12.220 Now, Rothbard applies the total demand stock analysis. 77 00:07:12.220 --> 00:07:15.220 The reason why he does this, the reasons are twofold. 78 00:07:15.220 --> 00:07:19.220 Number one, everybody in the economy is a buyer and seller of money. 79 00:07:19.220 --> 00:07:22.220 Everyone is a dealer in money. I think Edwin Cannon may have said that. 80 00:07:22.220 --> 00:07:26.220 Everyone deals in money. They regularly give it away in exchange for goods. 81 00:07:26.220 --> 00:07:30.220 So they sell it and they regularly accept it in exchange for goods. 82 00:07:30.220 --> 00:07:34.220 They receive it for the things that they sell. 83 00:07:34.220 --> 00:07:38.220 That's number one. So at any point in time, there's a stock of money. 84 00:07:38.220 --> 00:07:42.220 Everyone is dealing in money. So everyone's holding it. 85 00:07:42.220 --> 00:07:48.220 So therefore, there isn't a specialized group of suppliers, a specialized group of demanders. 86 00:07:48.220 --> 00:07:55.580 as a Supplier and Demander, not at the same time, but in sequence. 87 00:07:55.580 --> 00:08:01.020 Secondly, the production of money, and this goes to really the qualities of money. 88 00:08:01.020 --> 00:08:05.780 The production of money is very, very small as a very, very small proportion, 89 00:08:05.780 --> 00:08:10.940 the annual production of the overall existing stock of money. 90 00:08:10.940 --> 00:08:14.740 So as I tell my class under a gold standard, for example, 91 00:08:14.740 --> 00:08:26.460 You still had all the quantity of gold that was dug up going to the time before, let's say, Jesus of Nazareth walked the earth. 92 00:08:26.460 --> 00:08:28.020 That gold is still in the world. 93 00:08:28.020 --> 00:08:36.580 The only gold that has been lost is that which is at the bottom of the sea where ships have sunk or that have been lost, has been lost in fires. 94 00:08:36.580 --> 00:08:47.680 Okay, so that production or that quantity, that sum of the annual production of gold has built up and is still in the world. 95 00:08:47.680 --> 00:08:55.080 And the annual production is a very small proportion of that. That's another reason why we would use the total stock, a total demand stock analysis. 96 00:08:55.080 --> 00:09:00.080 Okay, so that's what Rothbard uses. Now he immediately identifies two components of demand for money. 97 00:09:00.080 --> 00:09:05.580 This is one of his most important contributions in monetary theory. There are many of them, actually. 98 00:09:05.580 --> 00:09:10.060 The first point of the demand we all engage in when we go to work, 99 00:09:10.060 --> 00:09:13.100 and we sell our labor services in exchange for money, okay? 100 00:09:13.100 --> 00:09:19.860 Just as you demand apples or bottles of Dasani water, as Walter is now, 101 00:09:19.860 --> 00:09:22.980 of course he's not paying anything for it though, 102 00:09:22.980 --> 00:09:26.860 just as you would demand commodities by exercising a demand on the market, 103 00:09:26.860 --> 00:09:30.380 by giving something away from them, for them typically money, 104 00:09:30.380 --> 00:09:33.660 you demand money by selling stocks of goods that you own, 105 00:09:33.660 --> 00:09:36.560 or by selling your labor services. 106 00:09:36.560 --> 00:09:39.560 So that's the exchange demand for money. 107 00:09:39.560 --> 00:09:40.960 That tends to be pretty inelastic. 108 00:09:40.960 --> 00:09:46.360 In other words, if you have capital goods, consumers goods or natural resources, 109 00:09:46.360 --> 00:09:48.760 they don't tend to have any use value to you. 110 00:09:48.760 --> 00:09:51.960 So their supplies are very, very inelastic, 111 00:09:51.960 --> 00:09:53.660 which means that you're willing to sell all of them, 112 00:09:53.660 --> 00:09:58.260 regardless of what the prices would be. 113 00:09:58.260 --> 00:10:00.460 Labor is a little bit different. 114 00:10:00.460 --> 00:10:01.560 You have leisure preferences. 115 00:10:01.560 --> 00:10:03.360 There's this utility of labor. 116 00:10:03.360 --> 00:10:09.360 So, therefore, that introduces some elasticity into the so-called exchange demand for money curve, 117 00:10:09.360 --> 00:10:13.760 which is one of the two curves that make up the demand for money. 118 00:10:13.760 --> 00:10:15.560 Secondly, there's a reserve demand for money. 119 00:10:15.560 --> 00:10:22.060 We're actually all doing that right now by the very fact that we're not rushing out and going to local stores and spending it. 120 00:10:22.060 --> 00:10:23.860 That is, we're holding on to it. 121 00:10:23.860 --> 00:10:27.360 We've received it in the past and we've refrained from spending it. 122 00:10:27.360 --> 00:10:31.960 The money in your wallet, there had to be a conscious choice to refrain from spending the money you have in your wallet 123 00:10:31.960 --> 00:10:35.320 and the money that is now sitting in your checking accounts 124 00:10:35.320 --> 00:10:39.680 and other types of immediately convertible bank accounts 125 00:10:39.680 --> 00:10:42.200 or immediately redeemable bank accounts. 126 00:10:42.200 --> 00:10:43.800 That's known as reservation demand for money. 127 00:10:43.800 --> 00:10:49.120 That's what imparts the elasticity, the downward slope for the demand for money. 128 00:10:49.120 --> 00:10:51.920 So as Rothbard would point out, so if we add these two up, 129 00:10:51.920 --> 00:10:59.760 we get a downward sloping demand curve, which is elastic because of the reserve demand. 130 00:10:59.760 --> 00:11:07.360 I mean, I don't mean elastic in a slight sense of micro that it's, you know, has an elasticity greater than the absolute value of one or anything like that. 131 00:11:07.360 --> 00:11:11.160 I just mean that it's downward sloping. 132 00:11:11.160 --> 00:11:18.560 Why would the reservation demand for money, the amount of money that you want to hold in your checking accounts and wallets and so on, 133 00:11:18.560 --> 00:11:24.860 why would that be greater when the purchasing power of money is lower than it is when the purchasing power of money is higher? 134 00:11:24.860 --> 00:11:42.860 In this example, people in this economy want to hold 50 billion dollars when prices are low, 50 cents per yoga cone, or the purchasing power is high, and much, much, much more, 200 billion when the prices have quadrupled to 2 dollars. 135 00:11:42.860 --> 00:11:45.860 What explains that relationship? 136 00:11:45.860 --> 00:11:52.860 Well, people are interested not in the number of nominal money units that they're holding. 137 00:11:52.860 --> 00:11:59.860 Their interest is in how much they can purchase with that money. 138 00:11:59.860 --> 00:12:06.860 So they reserve to themselves a certain fund of purchasing power. 139 00:12:06.860 --> 00:12:12.860 So we have this total demand curve and we have the supply curve of money. 140 00:12:12.860 --> 00:12:15.860 I should put an M at the top of that. Maybe I did. No, I didn't. 141 00:12:15.860 --> 00:12:19.860 And that determines the equilibrium. 142 00:12:19.860 --> 00:12:28.860 Equilibrium is determined, though, at that point and no other point, by what we call monetary adjustment process, if I can just show you that symbolically. 143 00:12:28.860 --> 00:12:44.860 If we were at the, if we were at a point where we had an excess supply of money, let's say up here, if we were at point A, so that price were very low, people felt they only needed 50 billion dollars, 144 00:12:44.860 --> 00:12:49.860 But in fact, there was $100 billion worth of gold in the economy. 145 00:12:49.860 --> 00:12:52.860 People would feel that they have an excess supply of money. 146 00:12:52.860 --> 00:12:55.860 Money would exceed its demand. 147 00:12:55.860 --> 00:13:00.860 And as a result, people would get rid of money. 148 00:13:00.860 --> 00:13:06.860 They would rush out and they would begin to increase their demands for other goods and services. 149 00:13:06.860 --> 00:13:10.860 And as they did so, prices would rise. 150 00:13:10.860 --> 00:13:12.860 Naturally, the purchasing power money would fall. 151 00:13:12.860 --> 00:13:18.460 fall another way of stating as one over P since the denominator is increasing the 152 00:13:18.460 --> 00:13:25.060 that that ratio falls and as the value of each dollar falls people begin to 153 00:13:25.060 --> 00:13:29.220 realize that they need more and more okay so let's take an example if you 154 00:13:29.220 --> 00:13:31.980 were to tomorrow wake up and find that you had double the amount of money in 155 00:13:31.980 --> 00:13:37.020 your checking account in your wallets and so on okay that magically appears 156 00:13:37.020 --> 00:13:42.100 there you'd feel that you have excess amount of money in your wallet that is 157 00:13:42.100 --> 00:13:46.380 is that given your anticipated purchases over the course of the next few weeks 158 00:13:46.380 --> 00:13:50.440 and given any emergencies that may conceivably arise, 159 00:13:50.440 --> 00:13:52.140 you only need half the amount. 160 00:13:52.140 --> 00:13:54.860 Let's say you're holding 200, now you have 400. 161 00:13:54.860 --> 00:13:56.500 So you rush out and spend an extra 200. 162 00:13:56.500 --> 00:13:58.820 If everyone operates in that way, 163 00:13:58.820 --> 00:14:01.100 then there's a big increase in demand for goods 164 00:14:01.100 --> 00:14:03.780 and prices fall and the purchasing power of money falls. 165 00:14:03.780 --> 00:14:06.920 So that at the end of this process, as we'll see, 166 00:14:06.920 --> 00:14:10.440 the, what we call the real money supply, 167 00:14:10.440 --> 00:14:15.600 The amount that the entire billion dollars can buy has pretty much been cut in half. 168 00:14:15.600 --> 00:14:20.600 Prices are twice as high, so that a billion dollars can now buy half as many, 169 00:14:20.600 --> 00:14:26.680 I'm sorry, a billion dollars can now buy the same amount of yogurt cones and of pizzas and of other things, 170 00:14:26.680 --> 00:14:31.600 as 50 billion could have purchased under the higher purchasing power. 171 00:14:31.600 --> 00:14:34.480 Okay, so we move towards equilibrium through that process. 172 00:14:34.480 --> 00:14:38.560 On the other hand, if people in the economy are experiencing a shortage of money, 173 00:14:38.560 --> 00:14:44.600 This is a subjective state, that is, they feel that at a high price level of $2, 174 00:14:44.600 --> 00:14:50.040 they need more than the available $100 million worth of gold. 175 00:14:50.040 --> 00:14:52.920 They would then begin to economize on money. 176 00:14:52.920 --> 00:14:56.400 That is to say, they would stop spending as much now, 177 00:14:56.400 --> 00:14:59.680 and they would begin to hold more money, 178 00:14:59.680 --> 00:15:07.600 because their requirements for money, in nominal terms, are higher now. 179 00:15:07.600 --> 00:15:12.500 But as they did that, that would mean that they were refraining from purchasing goods. 180 00:15:12.500 --> 00:15:16.300 They could also increase their labor, by the way, and buy more money that way. 181 00:15:16.300 --> 00:15:20.900 But they're refraining from purchasing goods, prices fall, and the purchasing power of money rises. 182 00:15:20.900 --> 00:15:24.700 Eventually, the quantity demanded of money falls. 183 00:15:24.700 --> 00:15:30.300 Okay, they feel that they don't need as much at a purchasing power of one yogurt cone as they did at a half a yogurt cone, 184 00:15:30.300 --> 00:15:33.500 because now they have sufficient purchasing power. 185 00:15:33.500 --> 00:15:38.460 The real value of money has increased so that they are now satisfied at that lower price level. 186 00:15:38.460 --> 00:15:43.740 They can make their anticipated purchases and they have enough for any sort of buying opportunities 187 00:15:43.740 --> 00:15:50.540 that they might come across or emergencies that might arise during the period. 188 00:15:50.540 --> 00:15:54.940 Rothbard also talks about changes to the money relation, 189 00:15:54.940 --> 00:16:02.380 and that's simple enough to show that when the demand for money shifts to the right, 190 00:16:02.380 --> 00:16:05.980 I'm not actually going to do it on here, he does it in the book, but I'll just talk about it. 191 00:16:05.980 --> 00:16:11.040 If the demand for money shifts to the right, you're suddenly going to find that the equilibrium point of E, 192 00:16:11.040 --> 00:16:18.640 demand is to the right, quantity demanded of money is much more than it was greater than what it was before. 193 00:16:18.640 --> 00:16:22.240 Maybe people are more uncertain about the future, maybe they're fearing this recession, 194 00:16:22.240 --> 00:16:26.240 or they're fearing that they're going to be thrown out of work, or not get their bonuses, 195 00:16:26.240 --> 00:16:33.840 or possibly have their house in foreclosure. 196 00:16:33.840 --> 00:16:37.040 So the demand for money goes up due to greater uncertainty. 197 00:16:37.040 --> 00:16:40.940 And as a result, what you get is an increase in the purchasing power of money. 198 00:16:40.940 --> 00:16:43.440 So if the demand for money shifted to the right, 199 00:16:43.440 --> 00:16:48.740 so that people now demanded $200 billion rather than only $100 billion, 200 00:16:48.740 --> 00:16:52.440 you would get an increase in the purchasing power of money 201 00:16:52.440 --> 00:16:58.740 to the point where prices would fall because the way that people increase their demand is to refrain from spending money 202 00:16:58.740 --> 00:17:01.240 and we would have a higher purchasing power, okay? 203 00:17:01.240 --> 00:17:03.340 So now, yoga cones would have half the price. 204 00:17:03.340 --> 00:17:12.940 So, people, an increase of demand for money increases the real money supply, okay, which is M over P. 205 00:17:12.940 --> 00:17:15.740 You don't need the Fed to increase the money supply. 206 00:17:15.740 --> 00:17:22.340 The demand for money goes up, given a fixed supply of money, prices fall, we get an increase in purchasing power, 207 00:17:22.340 --> 00:17:27.260 and the real money supply, the amount of yogurt cones and pizzas that you can buy 208 00:17:27.260 --> 00:17:32.420 with the 100 billion dollars, the same 100 billion dollars, is now increased. 209 00:17:32.420 --> 00:17:40.180 So, since the real money supply increases, society is capable of increasing the real money supply, 210 00:17:40.180 --> 00:17:46.620 which is by having, by the market adjusting the purchasing power of money to the change in demand. 211 00:17:46.620 --> 00:17:51.140 Now, that change in demand or supply is called the change in the money relation. 212 00:17:51.140 --> 00:17:54.780 The term money relation was coined by Mises and Rothbard uses that relation 213 00:17:54.780 --> 00:17:59.460 because it's less cumbersome than saying a change in the demand for or supply of money. 214 00:17:59.460 --> 00:18:04.900 So we've talked about the money relation. That's what we are referring to. 215 00:18:04.900 --> 00:18:11.380 On the other hand, let's say now that somehow the government increases the money supply 216 00:18:11.380 --> 00:18:20.100 by, let's say, adding, you know, paper money to the money supply that is redeemable in gold 217 00:18:20.100 --> 00:18:21.580 with a fixed demand curve. 218 00:18:21.580 --> 00:18:24.260 Well, that drives down the purchasing power of money. 219 00:18:24.260 --> 00:18:27.380 People did not autonomously demand more money. 220 00:18:27.380 --> 00:18:29.980 Otherwise, they would have shifted their demand curve. 221 00:18:29.980 --> 00:18:33.020 As a result, as that new money comes into the economy, 222 00:18:33.020 --> 00:18:36.460 people begin spending it because it's in excess now. 223 00:18:36.460 --> 00:18:41.460 And as a result, that depreciates the dollar in terms of goods, 224 00:18:41.460 --> 00:18:43.260 causes purchasing power to fall, 225 00:18:43.260 --> 00:18:47.980 and it doesn't change the real supply of money. 226 00:18:47.980 --> 00:18:53.180 Because if money doubles, prices also double. 227 00:18:53.180 --> 00:18:58.220 So the numerator and the denominator increase by the same proportion. 228 00:18:58.220 --> 00:19:04.300 Therefore, as one economist, Charles Riess, a French economist once said, 229 00:19:04.300 --> 00:19:08.180 society is the master of velocity, and by that he meant demand for money. 230 00:19:08.180 --> 00:19:13.100 He says the state might be the master of the money supply, but society is the master of velocity. 231 00:19:13.100 --> 00:19:20.980 Which means that anything that the government can do with its money supply is really ineffective, okay? 232 00:19:20.980 --> 00:19:24.860 But the society is always effective in changing the purchasing power of money, 233 00:19:24.860 --> 00:19:28.620 and in that way changing the real supply of money. 234 00:19:28.620 --> 00:19:32.980 Whereas the state cannot necessarily change the real supply of money, it can temporarily. 235 00:19:32.980 --> 00:19:36.420 But in fact, when it sets off an inflationary process, 236 00:19:36.420 --> 00:19:39.860 it not only doesn't change the supply of money in the short run, 237 00:19:39.860 --> 00:19:43.780 It actually, the real supply, it causes the real supply to fall in the longer run, 238 00:19:43.780 --> 00:19:47.140 as people begin to demand, shift their demand for money back, 239 00:19:47.140 --> 00:19:53.980 because they expect higher and higher prices in the future, so they begin to spend down, OK? 240 00:19:53.980 --> 00:20:02.420 Right, so that's the changes in the supply of money and demand for money. 241 00:20:02.420 --> 00:20:07.700 I want to say just a bit about the utility of the stock of money. 242 00:20:07.700 --> 00:20:18.800 Remember, unlike any other good, the demand or the subjective value of money depends on it having a purchasing power, okay? 243 00:20:18.800 --> 00:20:21.700 What if all other goods had zero prices on the market? 244 00:20:21.700 --> 00:20:30.600 What if suddenly BMW, you know, was it 300 series, Mercedes 300 series, what if that was zero, okay? 245 00:20:30.600 --> 00:20:33.500 Would that make any difference to you on your value scales? 246 00:20:33.500 --> 00:20:37.600 No, okay, you'd rush out and you'd grab one. 247 00:20:37.600 --> 00:20:45.080 Or if producers goods of various kinds, if stocks suddenly had zero value, or zero price, 248 00:20:45.080 --> 00:20:53.640 not a zero price, that is, title ownership of ongoing concerns, you'd pick up those stocks, you'd grab up those stocks. 249 00:20:53.640 --> 00:21:03.280 So any real goods or non-monetary goods that have zero prices do not affect their usefulness and their utility to you. 250 00:21:03.280 --> 00:21:09.680 However, if dollars had a zero price, a zero purchasing power, you wouldn't want them, okay? 251 00:21:13.080 --> 00:21:17.680 And the reason is this, the sole purpose of buying money 252 00:21:17.680 --> 00:21:24.180 is the fact that you are going to re-exchange it in the less remote or more remote future. 253 00:21:24.180 --> 00:21:27.580 It could be tomorrow, it could be two weeks from now, okay? 254 00:21:27.580 --> 00:21:32.480 So, money is accepted and demanded to be exchanged. 255 00:21:32.480 --> 00:21:34.480 So it has to therefore have an exchange value. 256 00:21:34.480 --> 00:21:38.780 If it has no exchange value, no one's going to give you anything for it. 257 00:21:38.780 --> 00:21:43.080 That's how money differs fundamentally from consumer goods and producer's goods. 258 00:21:43.080 --> 00:21:49.780 We can also conduct the experiment of the economically ignorant but benevolent angel 259 00:21:49.780 --> 00:21:55.080 that wants to help society and passes up the opportunity. 260 00:21:55.080 --> 00:21:58.580 He could double consumer's goods or he could double producer's goods, 261 00:21:58.580 --> 00:22:00.480 but instead he doubles the money supply. 262 00:22:00.480 --> 00:22:06.380 Doubles the money supply, what happens? Everybody wakes up, they have excess cash balances, 263 00:22:06.380 --> 00:22:10.880 they rush out, spend those cash balances, prices pretty quickly double, 264 00:22:10.880 --> 00:22:14.480 and there is no ambiguous social benefit from that. 265 00:22:14.480 --> 00:22:20.080 Okay, yes, the people who get up earlier and spend before the monies, before the prices have risen benefit, 266 00:22:20.080 --> 00:22:24.780 whereas the people who get up later, the late risers, okay, like college professors, 267 00:22:24.780 --> 00:22:30.380 get beat out of some of their purchasing power because they're now spending at the higher prices, okay. 268 00:22:30.380 --> 00:22:37.380 However, had the angel doubled consumer goods, there is an unambiguous social benefit there. 269 00:22:37.380 --> 00:22:40.380 We can say there is an increase in social utility in the following sense. 270 00:22:40.380 --> 00:22:48.380 More human wants are satisfied for some people, while for others there has been no decrease in the satisfaction of human wants. 271 00:22:48.380 --> 00:22:54.380 On the other hand, if they double supply of capital goods and natural resources, the same thing is true. 272 00:22:54.380 --> 00:23:03.180 In the future, more human wants are satisfied and no fewer human wants, for other people, are impaired, okay? 273 00:23:03.180 --> 00:23:12.380 So, increase in consumer and producer's goods, unambiguously, increase social welfare for some, 274 00:23:12.380 --> 00:23:18.380 or increase utility for some without impairing welfare for others and therefore increase social utility wealth. 275 00:23:18.380 --> 00:23:20.180 That is not true of money, okay? 276 00:23:20.180 --> 00:23:24.980 doesn't change the real money supply. 277 00:23:24.980 --> 00:23:33.540 So Rothbard arrives at this rule which was first clearly stipulated or stated by Ricardo, 278 00:23:33.540 --> 00:23:38.860 David Ricardo, the British economist, who had problems in sort of his value theory, 279 00:23:38.860 --> 00:23:42.360 but on monetary theory he was extremely good. 280 00:23:42.360 --> 00:23:47.900 And basically it's this rule that every supply of money, whether it's 50 billion, 100 billion, 281 00:23:47.900 --> 00:23:55.900 $200 billion yields the maximum usefulness of a medium of exchange, and an increase in money yields no social benefit. 282 00:23:55.900 --> 00:24:03.900 So in other words, compare three economies with the exact same makeup of the labor force, the exact same amount of capital goods, 283 00:24:03.900 --> 00:24:13.900 exact same amount of consumer goods. Is the economy with $200 billion in money better off than the economy with $50 billion? 284 00:24:13.900 --> 00:24:16.900 No, this is simply a difference in the price level. 285 00:24:16.900 --> 00:24:19.900 What about the demand for money? Why is there demand for money? 286 00:24:19.900 --> 00:24:21.900 We'll briefly touch on this. 287 00:24:21.900 --> 00:24:25.900 As I said, money is desired to be exchanged, and really for no other reason. 288 00:24:25.900 --> 00:24:30.900 But that does not imply that we want to immediately rush out and exchange money. 289 00:24:30.900 --> 00:24:33.900 We do not want to rush out and spend all the money. 290 00:24:33.900 --> 00:24:36.900 None of us, as soon as we get our paycheck, rush out and spend it all. 291 00:24:36.900 --> 00:24:40.900 We always retain or reserve some for our cash balance. 292 00:24:40.900 --> 00:24:50.340 Balance. So the utility in money rests in the fact that it gives us a fund of purchasing 293 00:24:50.340 --> 00:24:57.060 power that allows us to plan for the future, to make anticipated purchases in the future, 294 00:24:57.060 --> 00:25:02.620 to meet certain emergencies that are sort of unpredictable, to take advantage of sales 295 00:25:02.620 --> 00:25:07.180 opportunities that we see in stores and so on. If we have ready cash on us, it's easier 296 00:25:07.180 --> 00:25:10.220 to do that, and so on. 297 00:25:10.220 --> 00:25:13.020 If you contrast that to ERE, in the ERE, 298 00:25:13.020 --> 00:25:17.300 the timing and the size of all an individual's expenditures 299 00:25:17.300 --> 00:25:19.980 and receipts are known with certainty, 300 00:25:19.980 --> 00:25:22.140 which means that when an individual receives 301 00:25:22.140 --> 00:25:25.500 his or her income, they'll immediately either spend 302 00:25:25.500 --> 00:25:29.140 it on present consumer goods or invest it for periods 303 00:25:29.140 --> 00:25:33.220 that correspond to the times when they will need that money 304 00:25:33.220 --> 00:25:41.220 back for the completely known expenditures, the perfectly known expenditures, okay? 305 00:25:41.220 --> 00:25:49.220 So in the ERE, there is no utility for money, for money holding, and therefore, no one would accept money. 306 00:25:49.220 --> 00:25:55.220 So that's another contradiction in the ERE, but it shows, again, that it's uncertainty that lies, 307 00:25:55.220 --> 00:26:01.220 that is the root cause of the holding of cash balances, okay, uncertainty of the future. 308 00:26:03.220 --> 00:26:09.220 Now, that's not to say there are not many reasons for holding money, 309 00:26:09.220 --> 00:26:15.220 but the fundamental cause for holding money is uncertainty of the future, 310 00:26:15.220 --> 00:26:18.220 which brings us to speculative demand. 311 00:26:18.220 --> 00:26:23.220 One of the very important influences on the demand for money in the real world 312 00:26:23.220 --> 00:26:28.220 is the expectation that prices could rise in the future or fall in the future. 313 00:26:28.220 --> 00:26:40.220 So during the 1970s and 1980s when the prices were sort of the first housing bubble, I recall, I was a graduate student during that time, for a good part of that time, then a young faculty member. 314 00:26:40.220 --> 00:26:53.220 And many of my colleagues, our salaries weren't that high and so on, especially as teaching assistants or graduate assistants, began to run out and purchase houses that they were going to save up for the down payment on. 315 00:26:53.220 --> 00:27:01.220 So they began to purchase houses today that they would really optimally like to have purchased two years or three years down the road. 316 00:27:01.220 --> 00:27:09.220 People begin to purchase automobiles now. In other words, people move their purchases into the present when money has a higher purchasing power than it's expected to have. 317 00:27:09.220 --> 00:27:22.220 So during a period of, or during, when there's an expectation of a fall in the value of money, a fall in the purchasing power of money, you get a fall in the demand to hold money. 318 00:27:22.220 --> 00:27:27.340 doesn't disappear except if you have a hyperinflation but it falls people want 319 00:27:27.340 --> 00:27:32.500 to people economize on their cash balances on the other hand if next year 320 00:27:32.500 --> 00:27:38.340 if within six months we were all to expect that Bush but right before he 321 00:27:38.340 --> 00:27:41.540 goes out of office so whenever he's leaving office was going to immediately 322 00:27:41.540 --> 00:27:44.900 repeal all tariffs so he could be known in history as the greatest greatest free 323 00:27:44.900 --> 00:27:51.260 trading politician all barriers to trade we would know that many goods would fall 324 00:27:51.260 --> 00:28:00.260 So many of the things that we were planning on purchasing today, durable goods, we would then postpone the purchases to the future. 325 00:28:00.260 --> 00:28:06.260 That means that we would hold more money in our checking accounts and in our pockets and so on. 326 00:28:06.260 --> 00:28:13.260 Then Rothbard talks a little bit about the secular influences on the demand for money. 327 00:28:13.260 --> 00:28:19.260 Over time there are certain factors that cause the demand for money to increase and to decrease. 328 00:28:19.260 --> 00:28:32.260 For example, economic growth, increases in the supplies of goods and services. 329 00:28:32.260 --> 00:28:39.260 What that leads to is an increase in the amount of goods and services for sale on the market. 330 00:28:39.260 --> 00:28:45.260 That's an increase in the exchange demand for money, and therefore that shifts the demand curve to the right. 331 00:28:45.260 --> 00:29:01.760 If people are paid less frequently, and as the economy goes from a blue-collar economy to a white-collar economy, let's say from the 1950s, the transition that took place until today, 332 00:29:01.760 --> 00:29:13.260 what was happening was people were getting paid less and less frequently because office workers would get paid instead of every week or even every day, office workers would get paid every two weeks or every month. 333 00:29:13.260 --> 00:29:18.260 So as we have shifted from a manufacturing economy to a service economy, 334 00:29:18.260 --> 00:29:27.260 people get paid less frequently, so they have to hold larger cash balances to finance their anticipated purchases between pay periods. 335 00:29:27.260 --> 00:29:29.660 So that increases the demand for money. 336 00:29:29.660 --> 00:29:39.060 Just think of a professor who is a consultant to some firm and gets $100,000 at the beginning of the year. 337 00:29:39.060 --> 00:29:45.300 and that has to last him to his next consulting contract, let's say a year down the road, right? 338 00:29:45.300 --> 00:29:49.540 In the beginning, he's going to start with $100,000 and he's going to hold the average cash balance 339 00:29:49.540 --> 00:29:51.940 that he holds over the course of that year is going to be huge. 340 00:29:51.940 --> 00:29:56.500 If he spends that money evenly over the year, his average cash balance is $50,000. 341 00:29:56.500 --> 00:30:02.340 Whereas if he was getting his paycheck every two weeks, then it would be much, much smaller, okay? 342 00:30:02.340 --> 00:30:05.340 be the average over that two-week period. 343 00:30:11.340 --> 00:30:13.740 Now, there's often a confusion about the demand for money. 344 00:30:13.740 --> 00:30:15.340 People say, what do you mean, demand for money? 345 00:30:15.340 --> 00:30:17.340 I want as much money as I can get. 346 00:30:17.340 --> 00:30:18.340 Okay. 347 00:30:19.940 --> 00:30:24.340 Well, they're, in making that statement, 348 00:30:24.340 --> 00:30:26.340 they're confusing money with wealth. 349 00:30:26.340 --> 00:30:29.340 Yes, everyone wants as much wealth as possible 350 00:30:29.340 --> 00:30:31.340 because the greater the amount of wealth, 351 00:30:31.340 --> 00:30:41.840 If people really did have an unlimited demand for money, as opposed to an unlimited demand for wealth, 352 00:30:41.840 --> 00:30:46.840 well, then what would we see? What would we observe counterfactually? 353 00:30:46.840 --> 00:30:53.840 If people had an unlimited demand for money, as soon as they received any money, what would they do with it? 354 00:30:53.840 --> 00:30:56.840 They would hold on to it. They would never spend it. 355 00:30:56.840 --> 00:31:03.840 They would hold onto it, they would never spend it, and then it would all starve to death and then everybody would be dead and there would be any demand for money. 356 00:31:03.840 --> 00:31:07.840 But at least in the short run, people would never spend any of their money income. 357 00:31:07.840 --> 00:31:11.840 But in fact, we know that people don't act in that way. 358 00:31:11.840 --> 00:31:16.840 What people do do is to allocate their income on three different margins. 359 00:31:16.840 --> 00:31:21.840 They allocate it to spending it on consumption, by saving and investing it, 360 00:31:21.840 --> 00:31:34.140 and what's called in a non-normative way or non-positive way, they hoard it, okay, which simply means they add to their cash balance, they build up the amount of money they're holding. 361 00:31:34.140 --> 00:31:45.140 Those are three options open to them, okay, and, you know, I pose a question to my students, I say, you know, my students who say, no, there's unlimited demand for money. 362 00:31:45.140 --> 00:31:50.140 I said, well, what if you won $100 million in the lottery tomorrow? 363 00:31:50.140 --> 00:31:52.140 I said, you know, would you hold on to all of that? 364 00:31:52.140 --> 00:31:57.140 No, of course, I'd buy a boat, buy a better house to quit my job and so on, right? 365 00:31:57.140 --> 00:32:01.140 So, you see that they don't have an unlimited demand for money, okay? 366 00:32:01.140 --> 00:32:06.140 Whether, in fact, you're spending it or giving it away means that your demand is limited. 367 00:32:06.140 --> 00:32:12.140 It's always limited by your supplies of things that you can sell on the market as an exchange amount for money 368 00:32:12.140 --> 00:32:20.140 and even more narrowly by the amount or the proportion of that money that you receive in exchange that you keep in your cash balances. 369 00:32:22.140 --> 00:32:25.140 Now we come to the purchasing power and the rate of interest. 370 00:32:26.140 --> 00:32:32.140 Because of the influence of Keynesian economics, people still think, including many, many economists, 371 00:32:32.140 --> 00:32:40.140 that changes in the demand for money, if the demand for money increases, somehow that will increase, for example, will increase the interest rate. 372 00:32:40.140 --> 00:32:45.740 the interest rate. If on the other hand, there's a full demand for money, well then the interest rate will drop. 373 00:32:45.740 --> 00:32:57.840 Okay, well that's confusing a demand for loanable funds or for a savings on the part of someone who wants to use it for consumer purposes or investor purposes. 374 00:32:57.840 --> 00:33:02.440 That's confusing that with the demand for money itself. 375 00:33:02.440 --> 00:33:05.440 As I said, money is allocated on three margins. 376 00:33:05.440 --> 00:33:10.440 Consumption, investment and cash balances. 377 00:33:11.440 --> 00:33:14.440 What if, let me just give you a little numerical example here. 378 00:33:14.440 --> 00:33:17.440 What if we had an economy in which income, 379 00:33:17.440 --> 00:33:20.440 I want to be a heretic here and write Y for income, 380 00:33:20.440 --> 00:33:23.440 which is the Keynesian symbol for income, 381 00:33:23.440 --> 00:33:27.440 is a hundred ounces or a hundred dollars worth of gold. 382 00:33:27.440 --> 00:33:31.440 And let's say that in that time period, T1, 383 00:33:31.440 --> 00:33:39.440 People spend 20 on consumption and they save 80, okay? 384 00:33:39.440 --> 00:33:43.940 They don't add anything to their cash balances, they don't hoard any, they spend all their current income, okay? 385 00:33:43.940 --> 00:33:49.940 They're holding cash balances, okay, but they're keeping them the same, they're not changing their cash balance. 386 00:33:49.940 --> 00:33:55.940 Okay, and then suddenly we have an act of hoarding, that is in the next period, T2, 387 00:33:55.940 --> 00:33:58.460 People decide, because of greater uncertainty of the future, 388 00:33:58.460 --> 00:34:04.180 that they're going to spend less of that $100 in income on consumption goods. 389 00:34:04.180 --> 00:34:12.540 So let's say that falls to $15 and proportionally less on saving. 390 00:34:12.540 --> 00:34:15.180 Let's say that falls to $60. 391 00:34:15.180 --> 00:34:18.660 Well, what happens to the other $25 in income? 392 00:34:18.660 --> 00:34:23.020 They use that to build up their cash balances, 393 00:34:23.020 --> 00:34:26.420 to add to their purchasing power that they're holding. 394 00:34:26.420 --> 00:34:36.180 So, now you have hoarding of, let's put that in here, zero here, hoarding of $25. 395 00:34:36.180 --> 00:34:43.220 Now, Rothbard says is as long as the proportion of consumption to saving stays the same, 396 00:34:43.220 --> 00:34:53.500 as long as the CS ratio remains at 1 to 4, which it does, 20 to 80, and 15 to 60. 397 00:34:53.500 --> 00:35:00.420 As long as that ratio holds, that means that the stream of income, 398 00:35:00.420 --> 00:35:06.340 the way income is being divided between consumption goods... 399 00:35:06.340 --> 00:35:11.060 Walter, you're not a mathematical economist, I want to hear from you. 400 00:35:11.060 --> 00:35:13.700 Consumption-saving ratio, right? Am I correct? Yeah. 401 00:35:15.700 --> 00:35:18.060 Now I lost my train of thought, all right. 402 00:35:18.060 --> 00:35:23.940 That as long as that holds, the stream of income is being divided in such a way 403 00:35:23.940 --> 00:35:27.940 that the same proportion is being spent on investment goods in the structure of production 404 00:35:27.940 --> 00:35:30.740 as is being spent on consumer goods. 405 00:35:30.740 --> 00:35:39.220 So there's no greater profits to be made, no greater profit margin in any stage of production than there was before, okay? 406 00:35:39.220 --> 00:35:41.020 So the production structure remains the same. 407 00:35:41.020 --> 00:35:48.220 What Rothbard goes on to say is in time T3, of course, net income, in nominal terms, falls. 408 00:35:48.220 --> 00:35:55.820 It falls to the money paid out for consumers' goods and the money paid out on investment goods. 409 00:35:55.820 --> 00:36:02.320 So this falls to 75, and then this would be 15 and 60, and hoarding would fall back to zero. 410 00:36:02.320 --> 00:36:10.520 In other words, if people don't continually hoard, they wanted 25 more dollars in their cash balances, economy-wide, 411 00:36:10.520 --> 00:36:19.020 to meet the greater uncertainty that they feel existed, let's say, after 9-11, or when Y2K was upon them, 412 00:36:19.020 --> 00:36:25.520 or today, when they don't know what's going to happen to their houses and their jobs, and so on. 413 00:36:25.520 --> 00:36:30.720 So now what does happen? All nominal values in the economy fall, but they fall proportionally. 414 00:36:30.720 --> 00:36:35.520 Now, can hoarding cause a change in the interest rate? Absolutely. 415 00:36:35.520 --> 00:36:39.920 But that's hoarding in conjunction with a change in time preferences. 416 00:36:39.920 --> 00:36:45.920 What if instead of this, people decided they're just going to cut back on their consumption? 417 00:36:45.920 --> 00:36:48.920 So, let me think. I want to do it that way. 418 00:36:48.920 --> 00:36:53.520 Let's see, an increase in demand. Let's say there's an increase in demand for money, so that would raise interest rates. 419 00:36:53.520 --> 00:36:56.620 So let's do it in a way that it will raise interest rates. 420 00:36:56.620 --> 00:37:00.020 Let's cut back on people's savings. 421 00:37:00.020 --> 00:37:09.500 So now, what the people do is they cut back, the whole $25 comes out of saving, so we get another T2 prime, 422 00:37:09.500 --> 00:37:17.540 and so we have the same amount spent on consumption, but, I'm sorry, 20 on consumption, yeah. 423 00:37:17.540 --> 00:37:25.380 But instead of 80, we have 25 less, which is what, 65? No, 55. 424 00:37:25.380 --> 00:37:30.180 Okay, so saving equals 55, hoarding equals 25. 425 00:37:30.180 --> 00:37:31.680 Now look what has happened. 426 00:37:31.680 --> 00:37:34.580 The consumption-saving ratio has gone way up. 427 00:37:34.580 --> 00:37:37.880 The relative demand for consumer goods in the present has gone up 428 00:37:37.880 --> 00:37:41.980 in relation to consumer goods in the future, okay? 429 00:37:41.980 --> 00:37:47.080 Resources now shift out of the higher stages into the lower stages 430 00:37:47.080 --> 00:37:50.080 to supply the relatively greater demand for consumer goods. 431 00:37:50.080 --> 00:37:53.180 And as a result, the price spreads 432 00:37:53.180 --> 00:37:55.680 between the various stages of production increase, 433 00:37:55.680 --> 00:37:57.180 the natural rate of interest increases, 434 00:37:57.180 --> 00:37:59.680 and we see that being reflected on the loan market. 435 00:37:59.680 --> 00:38:02.980 But there, you had an increase in demand for money 436 00:38:02.980 --> 00:38:07.480 and a rise in the CS ratio. 437 00:38:07.480 --> 00:38:12.180 The CS ratio is a reflection of people's time preferences. 438 00:38:12.180 --> 00:38:14.580 So you've got a rise and it led to, 439 00:38:14.580 --> 00:38:17.680 sideways out, to an increase in time preferences, okay? 440 00:38:20.680 --> 00:38:22.580 Okay, I'm going to skip over the Keynesian, 441 00:38:22.580 --> 00:38:27.980 His critique of the Keynesian system will all entertain questions on that because I want to get to one other topic that's very important here. 442 00:38:27.980 --> 00:38:34.180 I will say, though, the whole Keynesian system, as Rothbard points out in his brilliant critique there, 443 00:38:34.180 --> 00:38:38.480 depends on confusing the notion of saving with hoarding. 444 00:38:38.480 --> 00:38:41.580 For Keynes, there was only... 445 00:38:41.580 --> 00:38:43.380 He could only think on two margins. 446 00:38:43.380 --> 00:38:49.980 He was accused of this by one of his fellow Cambridge economists, D.H. Robertson, who was actually a good monetary economist. 447 00:38:49.980 --> 00:38:52.380 Not a very good value theorist, though. 448 00:38:52.380 --> 00:38:56.100 And so what Robertson pointed out is that what Keynes believed was this, 449 00:38:56.100 --> 00:39:02.660 that people got income and they spent it on consumption, or they saved it, okay? 450 00:39:02.660 --> 00:39:09.040 Then, they went, and of course consumption was, they were sort of robots, 451 00:39:09.040 --> 00:39:12.620 whatever the current income was, depending on their marginal propensity to consume, 452 00:39:12.620 --> 00:39:14.940 that determined their consumption. 453 00:39:14.940 --> 00:39:21.920 In the case of saving, they then decided to save it as cash balances, 454 00:39:21.920 --> 00:39:25.400 or to buy bonds. 455 00:39:25.400 --> 00:39:29.640 So if they bought bonds, then the money was invested and so on. 456 00:39:29.640 --> 00:39:38.240 But if they put in cash balances, that then brought about a full money income. 457 00:39:38.240 --> 00:39:40.440 But Keynes, there's another area here. 458 00:39:40.440 --> 00:39:44.280 So let's even accept that kind of thinking on two margins. 459 00:39:44.280 --> 00:39:47.240 In fact, we know people simultaneously have one value scale. 460 00:39:47.240 --> 00:39:49.360 They don't have a value scale for consumption and saving, 461 00:39:49.360 --> 00:39:56.860 and then another value scale for, oh, should I take that and should I put it into my cash or should I buy bonds with it? 462 00:39:56.860 --> 00:40:03.560 They compared all of these things simultaneously on the single unitary value scale. 463 00:40:03.560 --> 00:40:12.360 But the other problem with this is that even if they did cause hoarding or hoard a lot of what they've saved, 464 00:40:12.360 --> 00:40:18.260 what difference does that make? As we've seen, all that does is to decrease nominal values in the economy. 465 00:40:18.260 --> 00:40:21.420 The Change of Purchasing Powered Money. 466 00:40:21.420 --> 00:40:26.380 The implicit assumption in Keynes was that wages were rigid. 467 00:40:26.380 --> 00:40:30.740 In fact, Keynesian economists, particularly Franco Modigliani, 468 00:40:30.740 --> 00:40:33.300 was a mathematical Keynesian economist 469 00:40:33.300 --> 00:40:35.340 and was sort of a general equilibrium thinker 470 00:40:35.340 --> 00:40:38.020 in a sense that he thought on all margins at least, 471 00:40:38.020 --> 00:40:42.180 saw right away that, and wrote a famous article, I think it was 1949, 472 00:40:42.180 --> 00:40:44.980 Henry Hazlitt actually reprinted it in his book, 473 00:40:44.980 --> 00:40:47.060 Critics of Keynesian Economics, ten years later, 474 00:40:47.060 --> 00:40:49.700 But he blew up the Keynesian system in 1949. 475 00:40:49.700 --> 00:40:51.900 He basically said, well, you know what? 476 00:40:51.900 --> 00:40:59.380 This is only all true if on the labor market, we'll make labor, forget about this utility of labor, 477 00:40:59.380 --> 00:41:03.020 there's a supply of labor, there's the demand for labor on the part of firms. 478 00:41:03.020 --> 00:41:08.460 If suddenly you had hoarding, then the demand for labor would shift down 479 00:41:08.460 --> 00:41:12.220 and everybody could keep working, the same number of workers would keep working, 480 00:41:12.220 --> 00:41:15.500 whatever it might be, X, zero X. 481 00:41:15.500 --> 00:41:21.300 As long as wages fell from W1 to W2, to the new equilibrium point. 482 00:41:21.300 --> 00:41:25.740 So what Modigliani said was that when this happened, 483 00:41:25.740 --> 00:41:33.620 this decrease in the demand for labor, wages were stuck up here. 484 00:41:33.620 --> 00:41:36.220 Okay, so there was, suddenly there was a surplus of labor. 485 00:41:36.220 --> 00:41:42.180 I didn't do it very well, but I'll do it over here for you. 486 00:41:42.180 --> 00:41:57.380 It's the labor market, thick supply, demand, okay, D1, D2, and we have a W1 and W2, the new equilibrium. 487 00:41:57.380 --> 00:42:09.180 So, if wages cannot fall from W1, then the number of workers hired falls from X to Y, okay, OX to OY. 488 00:42:09.180 --> 00:42:15.480 So Modigliani showed that the Keynesian system only made sense on the basis of this assumption, 489 00:42:15.480 --> 00:42:20.060 but he believed that the assumption was true, but at least he showed that theoretically it only made sense on the basis of that assumption. 490 00:42:20.060 --> 00:42:24.860 Was Keynes denied that in the general theory, and many of his followers denied that, okay? 491 00:42:24.860 --> 00:42:29.220 Today, the only economists that deny that are the so-called post-Keynesians, 492 00:42:29.220 --> 00:42:35.660 or the so-called new Keynesians like Paul Krugman and Mankiw and others. 493 00:42:35.660 --> 00:42:40.220 They all believe that you need this assumption. 494 00:42:40.220 --> 00:42:42.100 All the macro textbooks have this assumption. 495 00:42:42.100 --> 00:42:44.740 But they say this assumption holds in the short run. 496 00:42:44.740 --> 00:42:46.620 In the long run, markets clear. 497 00:42:46.620 --> 00:42:49.820 But why should we lose production and employment 498 00:42:49.820 --> 00:42:51.900 in the short run when we can easily cure it 499 00:42:51.900 --> 00:42:54.500 by having the government offset the hoarding 500 00:42:54.500 --> 00:42:57.980 or offset what they would call the fall in velocity 501 00:42:57.980 --> 00:43:01.300 and simply push the demand curve back this way? 502 00:43:01.300 --> 00:43:08.100 So, Rothbard shows this in great detail. 503 00:43:08.100 --> 00:43:11.400 Okay, the last thing I wanted to talk about, because I think it's so important, 504 00:43:11.400 --> 00:43:15.600 it's one of his most important contributions, 505 00:43:15.600 --> 00:43:23.300 one of his many important contributions to monetary theory. 506 00:43:23.300 --> 00:43:31.200 It's an area in which he corrected both Mises and Irving Fischer, father of modern monetarism, 507 00:43:31.200 --> 00:43:38.280 And he's still really the only economist that has grasped this point. 508 00:43:38.280 --> 00:43:41.680 And even he himself, I'll tell you about the conversation I had with him, 509 00:43:41.680 --> 00:43:48.520 didn't fully always adhere to this point because I had a little argument with him once about it. 510 00:43:48.520 --> 00:43:53.160 What Rothbard said was this, OK, if you've had macroeconomics, 511 00:43:53.160 --> 00:44:03.000 Next you know the standard story about how inflationary expectations or deflationary expectations 512 00:44:03.000 --> 00:44:06.840 affects the so-called nominal interest rate. 513 00:44:06.840 --> 00:44:14.400 The story is this, that if people expect inflation, this is called the Fisher equation. 514 00:44:14.400 --> 00:44:23.720 The Fisher equation is going to sum up their reactions to that expectation. 515 00:44:23.720 --> 00:44:28.280 And that is that the nominal interest rate will always equal the real interest rate, 516 00:44:28.280 --> 00:44:36.920 the pure interest rate, the underlying interest rate, plus the percent change in prices that 517 00:44:36.920 --> 00:44:40.000 are expected. 518 00:44:40.000 --> 00:44:44.920 So if the sort of pure time preference rate was 3% or something like that, whatever was 519 00:44:44.920 --> 00:44:49.760 determined by people's time preferences, and people in general had an expectation of a 520 00:44:49.760 --> 00:44:56.720 5% increase in prices, well then no one in their right mind would make a loan at 3%. 521 00:44:56.720 --> 00:44:57.720 Why? 522 00:44:57.720 --> 00:45:02.640 Because that person wouldn't even have the same amount of purchasing power at the end 523 00:45:02.640 --> 00:45:06.120 of the year as he started with at the beginning of the year, if it's a one-year loan. 524 00:45:06.120 --> 00:45:11.120 In other words, at 3%, he would receive back, let's say, $103 for the $100 he'd lent. 525 00:45:11.120 --> 00:45:18.120 But in the meantime, the cost of goods that he was purchasing with those $100 would go up to $105. 526 00:45:18.120 --> 00:45:25.120 So, and borrowers would acquiesce in this so-called purchasing power, what they call the price premium, 527 00:45:25.120 --> 00:45:31.120 what Fischer and Mises call the price premium. They acquiesce in paying that premium. 528 00:45:31.120 --> 00:45:33.120 Is that all on there? Yeah. 529 00:45:33.120 --> 00:45:38.120 And the reason why they would, because they themselves, when they had that $100, 530 00:45:38.120 --> 00:45:48.120 would experience by investing it in goods, an automatic 5% increase in prices over and above whatever real return they were expecting. 531 00:45:48.120 --> 00:45:54.120 So for Mises and for Fisher, 532 00:45:54.120 --> 00:46:00.120 they both believed that when you had an expectation of a decline in the parking car money, 533 00:46:00.120 --> 00:46:10.120 And that would be discounted into, or that would be folded into the nominal interest rate as a premium on the pure rate. 534 00:46:10.120 --> 00:46:15.120 Well, Rothbard looks at it a little differently. He says, no, wait a minute. 535 00:46:15.120 --> 00:46:23.120 He says, let's say that people, entrepreneurs expect an increase in prices. 536 00:46:23.120 --> 00:46:26.120 What are they going to do? 537 00:46:26.120 --> 00:46:28.840 He says, if it's expected, this isn't going to happen. 538 00:46:28.840 --> 00:46:31.840 He says, let's say someone's going to invest $100, 539 00:46:31.840 --> 00:46:35.280 and they expect that at the end of the year, they'll receive $105. 540 00:46:35.280 --> 00:46:41.280 That was the initial real expectation, that they'll get 5%. 541 00:46:41.280 --> 00:46:51.880 But now, suddenly, they realize that the money price will double to $210. 542 00:46:51.880 --> 00:46:59.280 Will we see appearing in loan markets a 100% price premium, 543 00:46:59.280 --> 00:47:05.080 or what Rothbard calls purchasing power premium, on the interest rate? 544 00:47:05.080 --> 00:47:06.600 Rothbard says, actually not. 545 00:47:06.600 --> 00:47:11.680 If these are the factors of production, so this is the total factor prices, 546 00:47:11.680 --> 00:47:17.640 the sum of factor prices, and this is the sum of the product prices, 547 00:47:17.640 --> 00:47:23.360 or you can just call this as the total revenue we'll get from spending that money on factor prices. 548 00:47:23.360 --> 00:47:26.200 What they're going to do is everyone's going to immediately rush out and do what? 549 00:47:26.200 --> 00:47:32.280 They're going to say, look, I'm going to make a huge return of 110% of my money. 550 00:47:32.280 --> 00:47:34.880 If everyone expected that, what would they do? 551 00:47:34.880 --> 00:47:39.560 They'd rush out and they'd bid up the prices of the factors of production 552 00:47:39.560 --> 00:47:47.560 so that they doubled to $200 because at that, their return is then still 5%. 553 00:47:47.560 --> 00:48:03.560 So Rothbard claimed that when you focus on the natural rate of interest, which is the fundamental or basic rate of interest, that is, that the rate of interest is formed in the structural production and the loan rate is simply a pale reflection of the structure of production, 554 00:48:03.560 --> 00:48:12.560 it's going to reflect itself in the natural rate first, it's going to affect the natural rate first, it's going to bid up, entrepreneurs will bid up the prices of the factors of production. 555 00:48:12.560 --> 00:48:20.560 So, for Rothbard, this was anticipated inflation. In fact, he stood Mises-Fischer on their heads. 556 00:48:20.560 --> 00:48:28.560 He says, actually, the premiums will appear when it's an anticipated inflation. 557 00:48:28.560 --> 00:48:37.560 Let's say now that no one expects it, so that we have $100 bringing in $210. 558 00:48:37.560 --> 00:48:39.960 People don't expect the doubling in prices. 559 00:48:39.960 --> 00:48:44.600 The sum of factor prices is 100, 560 00:48:44.600 --> 00:48:52.400 but the total revenue that the entrepreneurs receive for this investment is 210, okay? 561 00:48:52.400 --> 00:48:55.720 What has happened? 562 00:48:55.720 --> 00:49:03.240 There is a 100% premium in effect, inflation premium or purchasing power premium, 563 00:49:03.240 --> 00:49:06.880 on the natural rate of interest, okay? 564 00:49:06.880 --> 00:49:12.880 So that's when you get the is unexpected, but you get it. 565 00:49:12.880 --> 00:49:19.600 Now, there's an interesting implication of this for modern macro controversies, and I'll stop at this point. 566 00:49:19.600 --> 00:49:21.800 And that is the case of deflation. 567 00:49:21.800 --> 00:49:27.640 Bernanke and other economists are deflationphobes. 568 00:49:27.640 --> 00:49:30.720 And there are a number of reasons why they fear deflation. 569 00:49:30.720 --> 00:49:35.360 So let's talk a little bit about deflationphobia. 570 00:49:35.360 --> 00:49:41.160 I coined this term, I think, and Mark had it translated into Greek, so it sounded really cool. 571 00:49:41.160 --> 00:49:44.560 What was it called? 572 00:49:44.560 --> 00:49:45.960 Yeah, something like that. 573 00:49:45.960 --> 00:49:50.360 So it could actually be some sort of psychological disorder. 574 00:49:50.360 --> 00:49:52.960 Okay, the fear of falling prices is what was translated. 575 00:49:52.960 --> 00:49:53.760 Okay. 576 00:49:53.760 --> 00:49:58.360 In any case, one of the reasons why they fear inflation so much, 577 00:49:58.360 --> 00:50:00.760 and this is particularly Milton Friedman who makes this argument, 578 00:50:00.760 --> 00:50:10.320 is the following. If you expect, you have the Fisher equation here, plus percent change expected in prices. 579 00:50:10.320 --> 00:50:22.800 If you expect prices to fall by 10% in a year, and let's say you have 5% as the real rate of interest, so it's negative, 580 00:50:22.800 --> 00:50:26.880 Then, the nominal rate would be minus five percent. 581 00:50:26.880 --> 00:50:30.960 But no one would make a loan at minus five percent. 582 00:50:30.960 --> 00:50:34.440 Why? Because those people would rather just hold the money 583 00:50:34.440 --> 00:50:37.400 and then they would earn an automatic ten percent 584 00:50:37.400 --> 00:50:40.280 in the form of the increased purchasing power of their dollar. 585 00:50:40.280 --> 00:50:43.600 So, all investment would stop and we'd have a massive depression. 586 00:50:43.600 --> 00:50:44.920 This is the fear. 587 00:50:44.920 --> 00:50:50.760 This so-called lower bound of the nominal interest rate 588 00:50:50.760 --> 00:50:53.480 that cannot be pierced, okay? 589 00:50:53.480 --> 00:50:56.920 Well, of course, that's not a problem, 590 00:50:56.920 --> 00:51:00.280 because if in fact, we go back to our example here, 591 00:51:00.280 --> 00:51:04.920 factor prices, sum, I should have wrote total cost, but, 592 00:51:04.920 --> 00:51:08.840 all right, total revenue here, if factor prices are 100, 593 00:51:08.840 --> 00:51:15.600 and people suddenly expect not $105, but the price is to fall by half, 594 00:51:15.600 --> 00:51:20.720 so that it can now be sold for $52.5, okay, instead of 105, 595 00:51:20.720 --> 00:51:26.880 Wouldn't everyone stop investing and simply hold on to the $100, 596 00:51:26.880 --> 00:51:30.240 which would be twice as much purchasing power as they had at the beginning of the year, 597 00:51:30.240 --> 00:51:37.640 rather than giving up, rather than earning just a little bit of 5%. 598 00:51:37.640 --> 00:51:42.280 Well, the point is, yes, they would stop investing, but that wouldn't cause recession. 599 00:51:42.280 --> 00:51:49.640 They would stop spending money on their demands based on what they believe the discounted marginal revenue product 600 00:51:49.640 --> 00:51:57.540 to the factors, okay, which is P times marginal product discounted by the discount, by the interest rate. 601 00:51:57.540 --> 00:52:06.040 What they would do is they would, everyone would, the demand curve would shift the labor, would shift down. 602 00:52:06.040 --> 00:52:15.340 And I guess it would shift down so that, you know, wages would fall and prices and rents of all other goods that are used in production, 603 00:52:15.340 --> 00:52:17.740 and Capital Goods, and so on, would fall and land. 604 00:52:17.740 --> 00:52:26.260 And they would fall to the point where the return was, again, 5%. 605 00:52:26.260 --> 00:52:33.340 So it's precisely if deflation was expected that it wouldn't have any effect. 606 00:52:33.340 --> 00:52:38.500 You don't have to worry about the fact that the nominal interest rate cannot be less than zero. 607 00:52:38.500 --> 00:52:43.660 Rothbard pointed out that the whole problem with that Fisher-Mises analysis 608 00:52:43.660 --> 00:52:47.660 is that they don't focus on the natural rate of interest, okay? 609 00:52:47.660 --> 00:52:54.860 That is the interest determined as the rate of return on investment in the structure of production. 610 00:52:54.860 --> 00:52:57.060 And even if, what if inflation was unanticipated? 611 00:52:57.060 --> 00:53:00.460 If it was unanticipated, people would invest because they don't anticipate it, 612 00:53:00.460 --> 00:53:03.560 and instead of 105, they get 52.5. 613 00:53:03.560 --> 00:53:07.460 Would entrepreneurs go bankrupt as a result? 614 00:53:07.460 --> 00:53:10.560 No, because all prices are what? 615 00:53:10.560 --> 00:53:14.720 Half is high, so they're still earning five percent, okay? 616 00:53:14.720 --> 00:53:24.520 There would be a deflation premium though, or a deflation discount, retrospectively, retrospectively, okay? 617 00:53:24.520 --> 00:53:31.200 They earned in nominal terms, I don't know, about minus fifty percent, whatever it is. 618 00:53:31.200 --> 00:53:34.200 But they, in real terms, what did they earn? 619 00:53:34.200 --> 00:53:44.320 2.5 in real terms over 50 because what $100 bought before, $50 can buy today, so they earn 5% in real terms. 620 00:53:44.320 --> 00:53:47.880 Now the story about Rothbard, I'll stop. 621 00:53:47.880 --> 00:53:58.600 During the 1980s, the interest rate on bonds went very, very high after the inflation was stopped by Paul Volcker during the Reagan regime. 622 00:53:58.600 --> 00:54:09.640 And so, there was a big, a very high interest rate of, I don't know, 8 or 9% on bonds, on long-term bonds. 623 00:54:09.640 --> 00:54:13.520 So, I asked him, have you thought about it? 624 00:54:13.520 --> 00:54:21.000 And he says, well, you know, Joey says, they anticipate, you know, the bond market is anticipating inflation. 625 00:54:21.000 --> 00:54:25.240 And so, therefore, we have this premium. 626 00:54:25.240 --> 00:54:26.280 So, I said, wait a minute. 627 00:54:26.280 --> 00:54:28.720 I said, didn't you write in Human Action? I explained it to him. 628 00:54:28.720 --> 00:54:34.280 He goes, well, I'm just trying to work out the logical, the purely logical implications. 629 00:54:34.280 --> 00:54:38.120 He never really answered the question. 630 00:54:38.120 --> 00:54:42.920 He still thought, though, because he wrote something later on in Libertarian Forum or RRR, 631 00:54:42.920 --> 00:54:47.400 where he still had that inflation premium, the fiscal inflation premium in there. 632 00:54:47.400 --> 00:54:53.000 So it was even hard for Rothbard to be as rigorously logical as this book. 633 00:54:53.000 --> 00:54:55.480 The book is incredibly logical. 634 00:54:55.480 --> 00:54:58.840 It's just logical deductions, but this is the correct analysis.