Since this is the first time I'm speaking to you at this event,
I want to just give you some preparatory remarks here.
Let me just try to get you to appreciate the significance of this week.
There's really nowhere in the world, to my knowledge, that you can get something like this,
where it really is a graduate level program in Austrian economics,
or in this particular case, Rothbardian economics,
that, for example, at New York University, where I went,
Israel Kirzner was there at the time, and Mario Rizzo,
and other big names in the Austrian School and it was a, I don't know why, it was a highly ranked school
and you're getting a PhD in economics, so you might think that, oh, so you guys must have been up to late hours
talking about capital theory and no, I wasn't up to late hours, but I wasn't talking about capital theory.
The, so there, it was really, there wasn't even a class in Austrian economics.
It was just the weekly Austrian seminar that my dissertation happened to be in Austrian economics
and that's why I now work for these think tanks and I'm not teaching.
So there's nothing there that you could really get what we're getting here and then even at George Mason where you might think there's something like this I mean I haven't I didn't go to George Mason so I don't know for sure but my sense is there you get more like wow there's a lot of free market people here and there's a lot of libertarian guys and there's people like Pete Bakke who know Austrian economics and so if you take a class with him you'll get it but I don't think there's anything really like what you're going to get in this week and so because of that we
We really have to teach it as if this really is a serious seminar.
In other words, this isn't just a fun thing, let's come to Auburn and hey, we all like Rothbard and let's have a good time,
that this is actually fairly serious.
So that's the way I'm approaching this.
For example, I'm going to assume that all of you have read every word of this.
I don't know if that's true or not, don't tell me.
But I know some of you have, just looking at the questions that you guys wrote up or the comments.
So I know some of you really are, have read this and if you haven't, I would strongly suggest that, you know, now there's plenty of time built in at night, there's not, you know, instead of going down and getting drunk down the street, you can read this stuff and it'd be much better for you.
So that's where I'm coming from and like I said, I'm going to have to teach as if, because I know some of you have read that, because this is really the only opportunity I'm going to get to talk to those people who have read this.
And if we just try to talk and summarize in these lectures and say okay, in case you haven't ever heard of indirect exchange from the Austrian approach, let me tell you about it.
That's the kind of stuff we do at Mises University. So that's for kids. This is for adults.
So that's where I'm coming from. And again, just to illustrate why it's so important that when I go to Mises University and all these guys fly in here, I'm actually nervous.
What would happen if a tornado hit the Mises Institute and we all died?
What would happen to Rothbardian economics?
There would be a serious crippling blow.
And then the Sunday when people are going back
and I don't hear about any accidents from the Express 85 shuttle,
I start relaxing and I don't read about any...
You know, there's no plane crashes and I kind of calm down.
First of all, Peter Klein owes me money.
And so if his plane went down, you know...
Anyway, I'm being serious.
Of course, you can tell by my hairline, I worry about a lot of stuff.
and I worry about a lot of stuff but the point really is though that I mean there is this body of thought and it's a lot safer now we're more diversified you know it wouldn't be whereas like they were saying before if Murray Rothbard if a bus had hit him or something it probably there wouldn't be Austrian economics as we know it surviving so the point is just we have to pass this along and this is really the only time to do it at this level and so that's why I'm going to be assuming that you guys have read this even though maybe some of you haven't read
I've got every single word in this book. I'm going to have to talk to the people who have done that, because this is one of the rare chances we get.
Okay, let me also just talk, the things I'm going to be talking about this week primarily concern monetary and capital theory, and then that includes the business cycle,
because you really need to know the Austrian view of money and capital to understand the Austrian theory of the business cycle.
And those are two areas where, just hands down, the Austrian theory is just unambiguously better than mainstream economics, okay?
There's other areas where I can at least understand why a mainstream economist would be real haughty and look down on the Austrians,
like you guys are just using primitive techniques and come on, why don't you start using some more modern approaches?
And for certain very technical questions, certain real subtle things where you really have to balance
and it's a quantitative matter and how much of this factor versus this,
but are you being consistent in your thought process?
I can see where formal modeling is useful and I certainly understand why the people who teach that at the big universities,
why they think that their method is better than our method.
But when it comes to monetary and capital theory, like I say, it's not even close.
And just to sort of illustrate that, why this isn't just a, you know,
it's not like we have different schools of art appreciation and we like this school
This is really significant that the recent mess that's going on with the economy, with the housing crisis and then the related credit crunch and so forth, that stuff, regular mainstream economists, even free market ones in particular, they didn't see that coming at all, that I know lots of supply-siders, and they're very good economists. I'm not saying they're bad economists, but with the tools they use, the way they would just look out at the world and try to see what's going on and then give advice to other people who turn their backs on them.
The Theory of Money and Credit
So, on all those different areas, the free market economists could plausibly argue that
things should be great right now, and obviously they're not, and what that person was missing
is they don't understand the Austrian business cycle theory.
So if nothing else, by the end of this week, I want to get across to you how knowledge
of the Austrian business cycle theory really would have equipped you to understand that,
because it happened with me, that when I was working in a financial firm and I didn't see
I see all this stuff coming and then I did a consulting project for a bank and I just started looking at this stuff with fresh eyes because now I wasn't doing what my boss wanted me to do but I was on my own because I was doing the analysis myself so it wasn't going to have somebody else's name on it so I was just looking at it with fresh eyes and the stuff just jumped out at me and maybe in some of my later talks this week I'll show you the things I saw. So again, it's not that Austrian economics is a predictive, it's not correct because it predicts well. That's not the basis of it.
Validity, but it can't hurt you to have a correct theory in hand when you go out
and look at the world and like I say this is a case where it was just so
obvious the economy was on a brink of serious trouble and and like I said it
there really was a case where the Austrian economics informed me and the
other supply-side free-market economics just completely missed the warning
signals. All right so as far as this chapter goes let me let me just briefly
I briefly mentioned that, and I mentioned this in the study guide, a lot of economists, they use the terms barter and indirect, or they mean one thing by barter, they mean that there's not money, and Rothbard is using the terms interchangeably, barter and indirect exchange, and actually there's a slight difference, so I just want to point that out to you, it's not that what Rothbard's saying is wrong, but just be careful that here when Rothbard is talking about indirect exchange, that could include a scenario where there isn't yet a money,
And yet, there is indirect exchange, whereas if you're using the term barter to mean just a community where there's no money, then that's a broader definition.
And as we'll see, it really is, surprisingly, it's almost nonsensical to try to think through the logical consequences of what if you really just restricted it to direct exchange.
That's actually extremely limited, as we'll see, that it just, almost naturally, indirect exchange has to emerge.
And so the example that Rothbard talks about and that I elaborate a little bit on in the study guide is if you had indirect exchange, and again, just to reemphasize, what does that mean?
It's where you are exchanging in order to get something that you don't plan on using. It's not just for consumption, but you don't plan on using it in production either.
okay so you can have direct exchange where you're getting something that you
don't intend to consume but that you're gonna you're getting a producer good
that you want to use yourself in some process of production alright so that
also could be a case of direct exchange and indirect exchange obviously is when
you're the thing that you're trading away for is something that you're neither
going to consume nor use in production and as I say that's extremely limited if
You know, the standard stuff you'll hear about when you take any economics class and they talk about what are the advantages of money, you'll hear stuff that, you know, well, how could specialization occur because the dentist would have to find somebody who needed his tooth pulled and then had the exact things that the dentist wanted to buy that day and, you know, were the chances of those two things overlapping. And so you hear stories like that, but outside of Rothbard, I've never seen someone really
We delve into just exactly how important money is or indirect exchange is because it's a lot more than just that type of example.
It's a lot more than just specialization that just advanced production in and of itself really couldn't happen without indirect exchange.
And one of you asked a question about that, so let me just make sure you see why.
So you couldn't, or it would be very difficult if you wanted to build a house for you to hire other people to come and work on it
without engaging in indirect exchange, because you would have to have all of the things that you were going to pay them with just on hand.
You'd have to happen to have a bunch of food lying around or a bunch of soft drinks or whatever it is that these workers wanted in exchange for their labor
or the people who own the lumber that you needed for your house. You just have to have exactly what you wanted,
because the reason I say you would have to just happen to have that on you is because you couldn't say,
Okay, you know what, next week I want to build a house and I'm going to need some workers,
so I better go out in the market and get a bunch of steak and rice to give them so they
can work on my house, because in that case you would be engaging in indirect exchange
when you went out and got the steak, because you would be getting the steak not because
you wanted to use it, and not even because you wanted to use it to build your house,
but because you wanted to give it to somebody else for their labor, okay?
So that would, you know, the indirect, the prohibition on indirect exchange would prevent
you from doing that.
So that's the reason that if you really think through, it would be hard to do almost anything if you are outlying indirect exchange.
And so that's why it's a lot more than simply you wouldn't have specialization in different professions, that it's a lot more restrictive than that.
And then, of course, the whole notion of economic calculation, you need money in order to do that.
and that's again something that the Austrians recognize a lot more than other schools of thought would.
Now the, the definite, as Rothbard points out, the definition of indirect exchange, the distinction between direct and indirect exchange is pretty crisp,
but the definite or the borderline between what happens if something is a medium of exchange and then where do you draw the line between that and a money?
and Money. That's not crisp, because all money is a medium of exchange that is commonly accepted.
And so there's no crisp definition. And even right now, we're all sure, even though we don't think it's a good form of money, like a $20 bill in your pocket, that's money.
It's commonly accepted around here. But, I mean, there could be some guy out in the hills that you go to his house and you want to give him a piece of Federal Reserve notes for something, and he points a shotgun at you and says,
And so by the same token, if you're looking at a free market society, it's not necessary that every single person in the whole
So the whole community accepts gold or silver in order for those to count as money.
It's just a sort of vague command. It's commonly accepted.
So that's what Rothbard's getting at there, that distinction.
Whereas it is crystal clear if something is direct or indirect.
Now, as an outside observer, you might not know that.
You would need to know what the person's motivations were.
But the point is if the person who is acquiring something in exchange
is going to use it for consumption or production personally,
Let me talk a little bit about Menger's theory of the origin of money.
I think the next chapter talks about the regression theorem, so I'm not going to talk about that,
but let me just reiterate again what Menger's explanation for the origin of money is.
First of all, it's a strange type of theory.
So what Menger says is that goods have different, he called it saleability, and Rothbard uses the term marketability.
And again, this is even before money emerges, when you just have direct exchange, that is the case, that some goods just,
you have more people willing to accept them because those people happen to need it more.
There are some things that not very many people are going to use for consumption or production, and so they have a very limited market.
so they're not very marketable and and then over time is so people recognize
that and then once they realize that okay I have something very unmarketable
that I want to unload and what do I do well one way of achieving my end is to
trade it away for something that I don't actually want but that's more
marketable than the thing I got rid of and then that allows me to ultimately
achieve my objective and so that process you know you just think through what
would happen well then obviously that would just amplify the superior
and the marketability of the things that initially were more marketable
because more and more people would accept them in indirect exchange
and it's just a snowball process until Menger says that a few things just outstripped all others
and once it reaches the point where virtually everyone or it's commonly accepted
then that medium of exchange becomes a money.
So that's, as I say, I don't really know how to talk about that.
It's an interesting, it's not that Menger went and did historical research
There's a person, thousands of years ago, that said, you know, this is pretty dumb that we just engage in direct exchange
or that there's no commonly accepted unit of account and all these things that money does for us or this new concept.
So wouldn't it be great if we all just traded our goods against this one thing and then look at all the advantages that would flow from that.
So maybe a king thought of it or maybe someone smart person told the king and the king put out the decree.
And there's a lot of problems with that. So one thing is there's no record of that happening.
We think, you know, we know, or we think we know people who have discovered certain trigonometry results and things like that and, you know, smart people throughout history who came up with brilliant ideas.
We have an idea or there are records of those things happening. You would think if somebody invented money, we might know who that person was.
This guy was joking one time. He said, well, it wasn't John Money, but no, it wasn't John Money.
And so it's, it is, so that's sort of odd. And then, if you push it further though, how could, how would anyone ever even come up with that idea, if you didn't know what money was? Like it's really, if you just stop and try to think about what money is, it's a very odd thing.
And it's actually a lot easier to see how weird it is now when we have fiat money, that you, you know, you try to get your students to say, well, you know, why, why is it that you go and work all day at the factory in order for these pictures of paper with president's portraits on them?
And whereas if you say, why do you work all day for these bars of gold?
They might say, well, why wouldn't I work for bars of gold?
That's a great idea.
So it's actually a little bit easier to get people to see how strange it is that we trade things for money when it's fiat money.
And so the point is, can you imagine somebody before people recognize these advantages,
if someone just started talking about that, you know what?
And how about we all just, I don't know, let's take these seashells.
How about you give me your house and your cows and I'll give you 2,000 of these.
But don't worry because the guy down the street, he'll give you his telescope if you give those shells to him.
So go ahead and give me your house and I'll give you these shells.
And, you know, people would say, what are you crazy?
And so the point is you can't just force it, that if people don't accept something as a medium of exchange or as a money, you really couldn't force it.
And even if you tried, you could say, well, no, maybe there was a king that just, you know, at the threat of sword point made people do that.
You still need to run the problem of what prices should he set, because it wouldn't be enough just to say,
okay, from now on, shells are an acceptable payment, because then the guy with the house that the other person wants to take his house in exchange for shells,
he'll say, okay, the price is 18 billion shells.
And so you can see that it's not enough just to say, okay, now I'm a smart guy, I know about money, we're all going to start using it,
or else you get shot, because then you have to put in prices, and so you would have to plan the whole economy.
Another way of seeing it is if you're on a plane and it crashes in the mountains somewhere and you're isolated,
presumably the people there aren't going to be trading the cash in their wallets for stuff because they might say,
well, if we don't ever get rescued, I don't know. So they might not use those things as money anymore.
And even though everyone's from modern civilization, they all realize, you know, we really ought to have money.
They couldn't just say, OK, well, let's make these leaves of money.
So you know what I'm saying? Even if they all knew the advantages of money, they would have to emerge along the lines of Menger's story.
It might be quicker if they all knew what money was, but the point is you can't just pick something.
So anyway, these are all reasons that Menger was giving as to why the standard theory of where money came from really wasn't a compelling story.
Okay, let me move along. Another point I want to make sure we understand is, again, in a standard economics class,
They're going to talk about things that make for a good money and they'll talk about it's divisible, it's durable, ease of transport, and those are all true, but those are not the definition of money.
So the money is, at least in the Austrian approach, the definition is it's a medium of exchange that is commonly accepted.
Now if you want to understand historically why do gold and silver tend to be chosen as monies, at least in the modern period, it's for all those reasons I just said.
that you know it's hard to use cattle because they could die on you or it's hard to get them to go places and whereas gold and so in the same time you know platinum or other things they might be a little bit too valuable that it's you know in terms of the types of exchanges you're going to be engaging in gold and silver are just great for on many different reasons and there's nothing really wrong with them whereas everything else you might think of to use as money it might be good in some respects but there's really just one strike against it that kind of rules it out whereas gold and silver for the reasons I just mentioned
and we're really the best there was but again that's not and so that's why Rothbard talks about gold but just to be clear it's not that there that money has to be gold if you're a libertarian or an Austrian it's just that we think that's what the market would would adopt if it weren't forced under a different path and so that's why sometimes we loosely talk about gold and you might get the impression that oh it's got to be gold but no it's whatever the market picks but it historically picked gold for that reason okay let me
I'll put up a couple things here from the book, just going through it, I want to point out a few things.
Okay, so this equation up there, I mentioned it in the study guide.
Of course, you understand what Rothbard's talking about there,
but I think it's a little bit confusing to have the two nets in there,
that if you just got rid of this last phrase, the net addition to cash balance,
include both the inflows and the outflows, and so I think you could get rid of that.
The other thing is this equation, and then later on when he's talking about exports
and imports, he's not dealing with credit transactions, and I think he explicitly mentions
that in this chapter, that we're not going to deal with credit, we'll deal with that
later.
He does deal with it later, I think in the chapter Money and Its Purchasing Power, he
explicitly talks about that, but I'm just warning you, be careful here, it's that word
There's an income that's a little bit dubious there that really it would be more correct if he had here money inflow or something and you might say what's the difference, well just because in accounting if you go out and you take out a loan and you get a million dollars you're not going to call that income because you can't, you incur a debt to get that so it's certainly cash flow flowing in that you have control over now but it's not really income in the accounting sense.
about Credit Transactions then this is correct as it is and as I say Rothbard
was aware of that he just deferred the discussion so the same thing with the
exports and the imports I'm not going to get into it right now because it's not
really too relevant for this chapter but the issue with he talks about trade
deficits and really there's a distinction between a current account
deficit and it versus a trade deficit they're similar but they're not the same
thing so late after the session if you really if you're up if you're up late at
Night, saying, what's the difference between current account deficit and trade account deficit?
I'll allow you to get your sleep, but I'm not going to put the rest of you to sleep right now talking about it.
Another thing I want to mention here is, OK.
All right, so this chapter, or sorry, this figure, this is, you know, all these figures, they're all simplifications.
I mean this is ridiculously simplified, this isn't the economy, this isn't a picture of the economy.
The point is just to isolate certain concepts in the text.
And my point here is just to say that this is a lot better if you use this simplification
than if you use the circular flow that you'll get in a mainstream textbook.
All right, now you're not going to probably be able to read that because of the photocopying,
but it's saying up here that consumption purchases flow from,
The money from the public goes to businesses, and then in exchange for that, businesses give the public goods and services,
and then the public gives their productive services to business in exchange for the business paying wages, interest and profit to the public.
So this is the circular flow.
And if you're just studying this, this is from Samuelson's textbook, and the point here is that if this is the way you're thinking about general equilibrium,
And if this is the way you view the economy, you're not going to understand the Austrian business cycle theory.
You can't have a business cycle theory in here unless you do some aggregate under consumption or over investment theory.
There's no time lag in here. There's no way to show that the Austrian story itself you literally cannot put into this picture.
Now, in fairness, actually, Samuelson, the chapter I took this from later on, he gets into this stuff.
Samuelson actually is he's a very worthy adversary and so he does get into capital theory but the point is even more modern textbooks that sort of just crib from Samuelson's classic textbook they grab this and they don't take the other because it's just too complicated for you know most mainstream economists they don't worry about that so they're and we'll talk about this later when I get into the other capital theory chapters later on but it's true it's for those of you who are in grad school of mainstream
Eastern Economics, their formal tools, you can do a lot with it, you can take a lot of the verbal stuff from here and translate it into a formal model if you want,
and actually some of my own work, I have done that, but you wouldn't have known to do it if you didn't read it verbally, okay,
that you wouldn't have stumbled across that possibility if you were just studying these models because you're focused on finding equilibrium outcomes
you're trying to say oh well there's this new mathematical result is there a way I could use it oh yeah if we assume people's preferences are like this we can apply this theorem and that would be a neat result and so just like I say it's not that it's impossible to see some of the Austrian insights in a formal model but it's just it's very difficult and so that's why it's important that's why I was saying in the beginning of this talk that we want to pass this on to make sure that there are people reading reading this book that it's not enough just to you know even read the stuff
Study Guide, the study guide is just sort of refreshing your memory and you really need to read the original.
And then let me see, is there any other one?
Okay, let me also, I'm going to go about five or ten more minutes and then we'll open it up for Q&A,
but let me talk about a couple of these questions.
Somebody asked me, I think it wasn't clear from the question if it was supposed to be for this chapter, but let me just talk about this.
Okay, so now I need to chat. If I do Y, that unzooms it. Okay.
So somebody asked me to talk about consumer and producer surplus.
So this is the standard way you do it in a mainstream book.
So here's the demand curve and the consumer surplus is the area above the price line and under the demand curve.
And the idea is, and so the question was, you know, how do you guys feel about that?
Is this legitimate? I have mixed feelings.
It really is neat how you can show some of the problems with government intervention with these diagrams.
But it's probably a case of where you're using an invalid concept to make fun of the government.
And so you want to be able to do it.
But I'm not sure how I feel about this.
Clearly, if someone used this to show the market was bad, I'd say, this is a bunch of garbage.
So probably it is a bunch of garbage.
But let me show you why.
So the theory is, where they're coming from with this thing, is they're going to say, look, here for each unit,
Like, let's say this is the 10th unit, the height of the demand curve shows how much would people pay,
at what price would people demand 10 units?
And so...
All right.
And so, what that means now, we know, and this is, again, even in a mainstream undergrad class,
They're allowed, they would say this, that we know that people value at least the first nine units, you know, as more than that, or as much as that, and then the tenth unit, whatever this price is, if it's $10, and let's say this price is $4, and so the point is that, look, for each of these ten units, people would have been willing to pay $10 for each of those, and yet they're only having to pay four, and so there's that $6 surplus on each of those ten units,
And then you do that for each unit, and so you're summing up, you know, this surplus, this surplus, and so it's the area of that curve that's basically doing is showing you the benefits to the consumer from the existence of this market.
And so I like that, the idea of it, because it shows undergrads that it's not right to think, oh, someone walks into a grocery store and buys $120 worth of stuff and gives away $120 worth of stuff, namely cash.
And so both sides break even. That's a common way of thinking about it, but obviously, no, that's not right.
And so if you understand consumer surplus, that's one way to try to get it across.
Or another way of saying is, well, if I just took away the existence of this market, how does that hurt anybody?
And you could say, well, because they're missing out on this surplus that they would have been able to buy stuff at four.
And at least for these units, they valued them a lot more.
Now, I can say there's a couple of problems with this.
One thing is just on the face of it, it's adding up, it's trying to measure utility and so we know that that doesn't, that does not right.
That, so no matter what's going on here, if you think it's impossible to measure utility and this is purporting to show that you can measure how happy a consumer is because of a market, it can't be valid.
Specifically, what's another specific problem is, it's not true that if you set the price at 10,
you do know that people would have bought 10 units, but then you can't take the next step and say,
okay, what if you wanted to get people to buy 15, or we have to set the price at 7,
and then people would have been willing to pay $7 for the 11th, 12th, 13th and 14th and 15th units.
You don't know that because it's true that if the price is 7, they buy 15,
but they have more money at that point than they would have had if you first set the price at 10 and they bought and they gave you $100.
All right, so if you took $100 away from them and then lower the price to 7, it's not clear that they would have bought 5 additional units.
All right, but that's what's going on here.
It's assuming that it makes sense to say someone values the first unit at $100 and the second unit at 87,
and that you can sum up the valuations on all those units and that's the total amount that the person would pay to get all those units
and that's not necessarily true. So that's a specific sort of mechanical objection to what's going on there.
So anyway, that would be my response. Oh, and the other one, of course, is that it relies on calculus a lot,
the standard depiction when that's not really correct, but then even there you could say,
Okay, well what if we made it discreet, could you add up the amounts and again, I don't think it makes sense that what you're doing is first of all, not true that you could, it's not true the consumer would pay this plus this plus this on all these units, you don't know that, the demand curve doesn't give you that information and then it's also what you think you're getting and then adding them together, that doesn't make any sense. Okay, and then let me turn to another question. Somebody said,
Somebody said that, let's see here, referring to the marketability, I was trying to clarify that to say something's not marketable or has a low sellability, it's not the same thing as saying it's not valuable.
In fact, there could be things that are quite valuable, but they're not marketable.
So you can own a house, but it's not very marketable, and so it means, what I think it means is that how long do you have to spend trying to find what Menger called an economic price.
And so, as opposed to a $20 bill is extremely marketable, that you don't, what you're likely to get for it, you can go out and get very quickly.
In other words, you don't have to spend months looking for the best buyer for it, whereas you're selling a piece of art, you're selling an antique,
You're gonna do a thorough search for the right buyer, okay? So that's that's what I meant there. So someone
In response to that said it is noted that anything can be sold given a low enough price and then he asked
How do you sell ice to a penguin? Okay, so
First of all, you're right. I mean I had in mind if there's human buyers or rational actors at the penguin
I don't know has needs
The real answer there is, okay, I mean, I was, you're right, I probably didn't have this in mind, but technically you could lower the price to make it negative, so you could pay someone to take the thing off your hand.
So, you know, virtually for anything you can think of, you could unload it very quickly if you're willing to lower the price, even if you make the price negative.