This archived content originally appeared at Freebanking.org, the predecessor site to Alt-M.org, and does not carry the sponsorship of the Cato Institute.

Where was the Tom Woods Show when Hayek Needed It?

Tom Woods and Joe Salerno
Tom Woods and Joe Salerno

This morning Justin Merill alerted me, via Facebook, to a recent episode of The Tom Woods Show titled “Against Market Monetarism and NGDP Targeting.” The episode consists of an interview with Austrian monetary economist Joe Salerno, in which Salerno takes issue with Market Monetarists and, especially, with those current or former Austrians, including Larry White and me, who share Market Monetarists’ view that a well-functioning monetary system should avoid fluctuations in aggregate spending.

In the course of the interview Salerno, egged on by Woods, * suggests that when ostensible free banking proponents like Larry White and me treat stability of spending (MV) as a desirable monetary policy outcome, we implicitly endorse a centrally-planned money supply. Evidently it doesn’t occur to him that we like free banking precisely because we consider it, when combined either with a metallic standard or a frozen (or otherwise absolutely limited) stock of fiat (or "synthetic commodity") base money, an excellent device for achieving a stable level of total spending, and far superior in that respect to discretionary central banking. But you can hardly blame him for the oversight: after all, Larry and I have only pointed out this connection in just about every one of our writings on free banking, including my Theory of Free Banking, the first part of which is almost entirely devoted to showing how a free banking system tends automatically to stabilize spending.

It gets worse. When Salerno challenges what he refers to as “Larry White’s program” for having M change so as to offset opposite changes in V, Episode 361 of the Tom Woods Show graduates from scurrilous to spurious. “As people who believe in Austrian business cycle theory will tell you,” Salerno declares, “any creation of money by the Fed always goes through credit markets. That pushes interest rates down below their natural level. And that brings about the series of events that we know as the Austrian business cycle theory. So we think that is not a good policy; it’s a dangerous policy.”

The only problem with this argument is that at least one person who most certainly believed in Austrian business cycle theory would not have agreed with it. No biggie, right? Well, it wouldn't be, were it not for the fact that the person in question happens to have been … Friedrich Hayek, the Austrian business cycle theory's most important elaborator and exponent.

Though before he put the finishing touches on his famous theory Hayek shared Salerno’s preference for a constant money stock, he changed his mind in the course of writing his best-known works on the subject. Hayek’s mature understanding made its debut in the first English edition of Prices and Production (1931, p. 297), where Hayek observes that “[a]ny change in the velocity of circulation would have to be compensated by a reciprocal change in the amount of money in circulation if money is to remain neutral toward prices.” Somewhat later, in his essay on “Saving” (1933), Hayek observed that “Unless the banks create additional credits for investment purposes to the same extent that the holders of deposits have ceased to use them for current expenditure, the effect of such saving is essentially the same as that of hoarding and has all the undesirable deflationary consequences attaching to the latter.” Apart from minor modifications, this remained Hayek's theoretical position throughout the remainder of the 1930s and for some time beyond.

So, if Larry White doesn’t know his Austrian business cycle theory quite as well as Joe Salerno does, he shouldn’t feel too bad about it: after all, he’s in pretty good company.
__________________
*Apologies to Tom for my inaccurate first impression.

Addendum 1(3-21-2015): As some readers have misunderstood me on the point, let me make clear that I do not mean to suggest that Hayek himself favored discretionary central banking as a means for implementing his ideal! His position resembled White's in that he favored a rule-based system founded on gold convertibility while viewing central banks as the main cause of the then-existing system's failure to approximate his ideal. In fact Hayek resisted calling for monetary expansion in the 30s despite the collapse in spending that had occurred–though he came to regret having done so. The fact remains that Salerno's characterization of the Austrian business cycle theory is inconsistent with Hayek's own understanding.

Concerning Salerno's suggestion that it is wrong for White and others to endorse or rationalize expansionary central bank action even as a "second best" alternative, see my previous post on the matter, the gist of which is that it's meaningless to suggest that a central bank, assuming one exists, "do nothing." Consequently it's impossible to avoid implicitly endorsing a second-best alternative that could be construed as offering "advice" to a central planner. That is what Joe Salerno effectively does in arguing for a constant-M ideal. It is also, in effect, what Hayek did, to his ultimate regret, when he opposed Bank of England expansion in the early 1930s. My point isn't to condemn the implied advice in either case, but simply to point out that saying that a central bank should "do nothing" can also be construed–unfairly–as endorsing a particular monetary central plan.

Addendum 2(3-21-2015): Bill Woolsey weighs in on Salerno's notion of monetary neutrality.

  • https://www.facebook.com/#!/trollyball.mvp Scott Burns

    How do Salerno et al. respond to the criticism that I believe you (and Horwitz 2000) raise about the asymmetry some Austrians have regarding monetary induced inflation/deflation: If 'price stickiness' isn't much of an obstacle for market actors during a (monetary-induced) deflation, why aren't prices just as able to quickly and costlessly respond to increases in the money supply by the central bank, eroding the foundation of ABCT?

    • George Selgin

      So far as I'm aware, Scott, none have ever offered any response to it. Perhaps they are too busy trying to paint us as a couple of would-be central bankers!

      • Clearskys

        "why aren't prices just as able to quickly and costlessly respond to increases in the money supply by the central bank…?"

        Prices are responding just maybe not where we would like them to. Stocks, bonds, housing… all have responded but the real wages remain stagnant. The point has been made I think many times over: we can inflate but we can't control which prices the added money will end up bidding up, creating even more market distortion.

        • Rick Fitz

          That is why the current bubble is so terrifying. All this "new money" has bid the prices of equities so high that any loss of the monetary stimulus would render the value of the underlying assets unsalable at current prices. The deflation of the underlying asset chain will be worse than 2008. Without zero interest stock buybacks will kill EPS.

          All a result of central banks.

      • martin linsky

        Salerno did in his essay "Coordination in Austrian Macroeconomics".

  • http://vikingvista.blogspot.com vikingvista

    To a full reservist like Woods or Solerno, a totally free market in money and banking would lead to market abolition of fractional reserve banking. So whereas a free banker recognizes that merely freezing the monetary base as just one part of a more extensive central planning regime would be a poor way of approximating a free market, a full reservist sees it as a pretty reasonable approximation.

    What one advocates or criticizes the central banker for depends upon whether or not one believes fractional reserve banking per se is natural and beneficent or artificial and pathologic. And on this, the free bankers have put the full reservists to shame.

    • George Selgin

      But vv., I have myself have argued (in Theory of Free Banking) for a frozen base and a free market in banking (which would result in a fractional-reserve free banking system, according to my own understanding). So in what sense am I, in offering that proposal, to be regarded as being more of an apologist for central banking than a full reservist who also argues for a frozen B? I believe my proposal would give rise to a system approximating constant MV; the full-reservist believes his would lead to one approximating constant M. But what, in this case, could justify his claiming to being a more consistent opponent of central planning of money than I am?

      • http://vikingvista.blogspot.com vikingvista

        "I have myself have argued (in Theory of Free Banking) for a frozen base and a free market in banking (which would result in a fractional-reserve free banking system, according to my own understanding)"

        Yes, I know. A frozen base and a free market is not the same as a frozen base and NOT a free market.

        "So in what sense am I, in offering that proposal, to be regarded as being more of an apologist for central banking than a full reservist who also argues for a frozen B?"

        You aren't. Even if you argued for a fixed base while retaining the rest of the central planning regime (as did the 2 full reservists in this case), you wouldn't.

        "I believe my proposal would give rise to a system approximating constant MV; the full-reservist believes his would lead to one approximating constant M"

        Yes, this is what I was referring to.

        "But what, in this case, could justify his claiming to being a more consistent opponent of central planning of money than I am?"

        Nothing that I could think of, which is why I posted what I did.

        I'm not a particularly clear writer, I know, but I don't see any typos in my post. I'm just a soul whose intentions are good, o' Lord please don't let me be misunderstood.

        • George Selgin

          Ah. I see now. In fact, I had thought to criticize Salerno along these lines–for being the greater advocate of central planning. But I didn't wish to open that other can of worms!

        • GoldMoney

          Gimme a break. In a free market, the monetary base would not be frozen. It would be impossible to carry out as well. Growth of the money supply would come only from mining and melting precious metals. It would all depend on legitimate individual preferences. Nobody would block that free market process. The only thing is: nobody would choose FRB, for many reasons.

          • http://vikingvista.blogspot.com vikingvista

            The question is, who is the greater defender of central planning,

            (1) the person who advocates that a central planner hold fixed the monetary base while maintaining his other economic controls,

            (2) the person who advocates that the central planner change his target to more closely mimic the stabilizing monetary effects of a free market, or

            (3) the person who advocates a fixed monetary base in a (perhaps otherwise) free market.

          • Rick Fitz

            What is "fixed" about a de facto "gold standard" in a free banking market? All three of your choices are flawed, since all seek central power over some aspect of life.

      • GoldMoney

        Why would anyone in a free banking market be interested in "a constant MV"? And on which "level" should MV be held constant? And why exactly THAT level? And who would carry out such a policy? Would anyone agree? And since when is a policy (= central planning) of MV a free market phenomenon? Besides, the Fisher equation is hopelessly flawed.

        • http://vikingvista.blogspot.com vikingvista

          Why should anyone in a free market be interested in a "market clearing price"? And what should that price be? And why that price? And who would carry out such a policy? Would anyone agree? And since when is a policy (= central planning) of a market clearing price a free market phenomenon? Besides, supply and demand analysis is hopelessly flawed.

          • GoldMoney

            Your thinking is just as fallacious as that of the free bankers'. A market clearing price is simply the unhampered outcome of demand and supply. That's the nature of a free market, of free people. Nobody would be against such honest prices. That completely differs from "keeping MV constant", which consists of FORCING prices to stay at a certain "level".

          • http://vikingvista.blogspot.com vikingvista

            What do you think the effect of an unhampered free market is on MV?

          • Andrew_FL

            Better question, Vikingvista: how are Rothbardians imagining the Hayek Rule is achieved?

            Apparently GM is under the impression it involves widespread price controls. I mean the statement that "That completely differs from "keeping MV constant", which consists of FORCING prices to stay at a certain "level"." is just completely ridiculous. If the price level is constant, MV varies with the volume of trade, it's not constant at all.

            I'm sorry is it too much to ask that critics of Free Banking and the equation of exchange understand algebra before making comments like this?

          • GoldMoney

            Bouncing questions is not an answer; if anything, it proves you don't have any answers. Concerning this: "What do you think the effect of an unhampered free market is on MV?" It's at best irrelevant. MV is part of a fallacy (the Fisher equation), only interesting for academics that don't understand free markets.

          • George Selgin

            GoldMoney, like many libertarians, assuming that's what you are, you confuse your fondness for free markets with knowledge of economics, and of monetary economics in particular. Yes, some great economists have favored free markets, and in some cases to the point of wanting to keep governments out of the money business in some fashion or other. But a mere fondness for free markets and free money doesn't make one a monetary economist, and certainly doesn't make one fit to pass judgement on Irving Fisher, who was a darn good monetary economist (though not one I always agree with) or on the merits of MV=Py (which, as usually understood, is a simple tautology).

            In fact the things you say reveal no grasp of the subject. It is nonsense, for example, to speak as if there could be any such thing as well-defined market-clearing prices that are independent of central bank policy in a fiat money economy. You may wish for a gold standard and for prices based on such–nothing wrong with that. But you can't say, with reference to conditions today, "I want prices to be left to supply and demand instead of being influenced by a stable MV policy." Under our system, like it or not, the Fed's policy stance is a crucial determinant of "demand" for all goods and services. So, where "market clearing" prices settle depends on what policy the Fed follows.

            You are of course also entitled to say that you want nothing to do with the current system of fiat money. That's fine. But while you wait for a gold standard revival, the Fed keeps up its shenanigans, and people suffer from it. Those who want to limit the damage it does by making it follow a strict rule may be recommending a remedy that is, in your view, far inferior to the gold standard revival you wish for. But their remedy is then at least a form of first aid, whereas yours is nothing but a long-run hope. To complain about the first aid as you and other hard-money stalwarts do is like criticizing a man for applying a tourniquet to the victim of a rattlesnake bite, for not administering anti-venom instead, even though the nearest source of antivenom is hours away.

          • http://vikingvista.blogspot.com vikingvista

            GoldMoney,

            "Bouncing questions is not an answer; if anything, it proves you don't have any answers."

            Perhaps Plato was the most notoriously vacuous human who ever lived.

            "Concerning this: "What do you think the effect of an unhampered free market is on MV?" It's at best irrelevant."

            Irrelevant as in, 'The performance of an economy is independent of changes in MV', or irrelevant as in, 'I don't know'?

            "MV is part of a fallacy (the Fisher equation)"

            Is it that you don't think there is such a thing as total expenditures? Or is it that you don't think there is a total quantity of money? What exactly is the argument that you consider to be a "fallacy"?

          • http://vikingvista.blogspot.com vikingvista

            Andrew_FL,

            "is it too much to ask that critics of Free Banking and the equation of exchange understand algebra before making comments like this?"

            I don't think it is reasonable for you to expect a knowledge of algebra from people who still struggle with arithmetic and semantics.

        • Andrew_FL

          Vikingvista, surely you meant to say Socrates, not Plato? It is after all called the Socratic Method.

          About Plato I have little adulatory to say at all, so I shall say nothing.

          Anyway I'm afraid you're right, it probably is too much to ask. Still, it was a point worth making in hopes that others may see how hopelessly confused GM is about how the Hayek Rule actually works.

          • http://vikingvista.blogspot.com vikingvista

            "surely you meant to say Socrates, not Plato? It is after all called the Socratic Method."

            Is there something we know about Socrates (especially the socratic method) that didn't come from the mind of Plato? Surely I'm not the only one who thinks about them this way.

          • Andrew_FL

            Fair point. I just don't like Plato, is all.

    • GoldMoney

      Of course would fractional reserve banking be abolished in a free market. That would above all be the free people's OWN choice and NOT be the result of any central planning (which FRB is). Because: who in a free market would like to have the purchasing power of his money eroded by bankers creating unbacked money with the press of a button, who would choose a bank that is prone to bankruns or even bankruptcy because of this, who would leave his money with a bank that could suspend payment of gold and silver at any moment? Who would be interested in "monetary equilibrium" (vague abstraction), "monetary policy" (please no) or FRB to fulfill the "demand for money" (ancient fallacy)? Nobody. A free market in money and banking would lead to 100 percent gold and silver banking. Protection of private property is the first and last priority of people and in a free market that would be secured best. Period.

      • George Selgin

        GoldMoney, I have a vague feeling I've heard all of this before.

        • Rick Fitz

          Dr Selgin-

          I see that this is a new blog, and some of the comments are enlightened.

          I have been studying Austrian economics, as a hobby, since the mid-90s, and as far as I can tell, the only schism is w/r/t whether free-banking would work in a purely Austro-libertarian society, where freedom of contract is respected.

          I look forward to reading some more.

      • http://vikingvista.blogspot.com vikingvista

        Who in a free market would be interested in pooling their lending in the hands of established lending specialists while choosing among varying degrees of liquidity? Almost everyone, it appears.

  • thomas

    As you appear to be posting addenda from April 21, 2015, could you please send back to us some stock tips to use over the next 30 days? For some reason, ABCT isn't making any firm predictions…

    • George Selgin

      Cute, Thomas. Alas, no time travel was involved. I have fixed the dates, and appreciate your alerting me, however cutely, to my error.

  • JoeEsty

    Salerno responds… and wins again.

    “Selgin Rides Again”
    http://mises.org/blog/selgin-rides-again

    • George Selgin

      Can't win 'em all.

      • martin linsky

        Say what you guys want about the Mises.org bunch, but the people on here are just, and I use this word specifically, the whiniest bunch of bitter pussies I've seen in some time. Salerno and others always respond respectfully and give their opponents just due, but Selgin and others just sound like bitter teenage girls who cant get over a break up.

    • http://vikingvista.blogspot.com vikingvista

      "But I have never argued that a constant money stock is optimal."

      He lost me at this straw man.

  • Warren

    What is amusing about all this is that the 100% reservists never acknowledge the success that was Scottish free banking.

    120+ years of crisis free banking that saw many banks fail but yet there were no runs and a very, very low loss to depositors.

    All this with gold reserves getting down to 2% in cases and in one case 1/2 a percent!

    They also miss that the engine of this whole thing was the redemption system. A bank could not get too out of line with issuing notes because in just a fortnight those would be coming back at them and eating at their gold reserves if they issued too many. Go past the gold reserves and then you're into the very personal wealth of the stockholders of the bank. This was a double-barrel worth of discipline to the bankers. Very powerful means of keeping the bankers in check.

    So really the only needed defense against these ill-informed screeds is pointing at the redemption process and the unlimited liability of the stockholders and then mentioning the multi-generational run of success that the system had.

    And the supply of money is not contingent on the amount of metal dug out of the ground.

    As I understand it banks in the Scottish era would make loans to people secured by collateral and then would issue banknotes based on some percentage of that collateral's value. And that's how notes got into the system. In other words the notes were backed by land or a stream of payments or such like.

    So just because the notes were not backed by gold does not mean they were unbacked or that the bankers could print as many as they wished.

    I've been trying to get the phrase 'fractional gold reserve banking' into circulation to differentiate the concept from the standard notion of 'fractional reserve banking' but alas, no luck so far.

    As to why someone would be a customer of a FGR bank instead of a 100% reserve institution is that the FGR model is superior. If you are loaning out 98% of your gold that is a lot of interest coming in that can go to stockholders and depositors versus just the storage fees that a 100% reserve place can charge.

    And as Selgin and/or White have pointed out before: If 100% reserve banks were the preferred option then where are they in the historical record? Why is it that banks, and mostly unregulated banks at that, were everywhere serving just about every layer of society and are well known to this day but 100% warehouses are not?

    Do the 100%ers really think that full gold reserve banks will become the big thing? They're not illegal now, so where are they? Where are the great entrepreneurs raising big money for a chain of gold warehouses?

    All that said I have no problems whatsoever if people want to do that. Go for it. But I think you'll be unpleasantly surprised at how little traction you get in the market.

    • Andrew_FL

      Near as I can tell the tactic is to deny that Scotland really had Free Banking. And not on the grounds of Unlimited Liability (How could they? I think Rothbard was against LLC's).

      That being said, and while I agree for many reasons that in a true free market you'd still have fractional reserves, you're not going to get anywhere with the Rothbardians by asking why warehouses don't currently out compete fractional reserve banks. Their whole argument is that government support gives fractional reserves an unfair advantage.

      The better question is why even in the absence of government support, fractional reserves have persisted and warehouses haven't put banks out of business. The answer they give is essentially to deny such a thing has ever occurred.

      Besides which you can warehouse your money today. It's called a safety deposit box.

      • Rick Fitz

        Rothbard has no problem with fractional reserve banking in a free market, he just posited that it would fail.

        • Warren

          For a guy that prided himself on the accuracy of his historical research he sure screwed the pooch on Scottish banking.

        • Andrew_FL

          This is untrue, or are you unfamiliar with his calls for anti-Fractional Reserve vigilante mobs?

  • Clearskys

    "Their whole argument is that government support gives fractional reserves an unfair advantage."
    I think it's unfair to pretend that monopolistic Legal Tender Law has no effect on the outcome. Try issuing money and see how fast you end up behind bars.

    • George Selgin

      Legal tender laws have nothing to do with fractional reserve banking. Nothing. They influence the choice of base money, not commercial bank reserve ratios.

      In any case there was and still is no such thing as "legal tender" in Scotland. Neither Scottish banknotes nor Bank of England notes are legal tender in Scotland.

      There is no saving the anti-free-banking claim that fractional reserves would not survive in a free market: it is overwhelmingly at odds with the evidence. The refusal to take such evidence seriously–and the tendency to "guess" (or "theorize") about things rather than consult the facts–ought to be considered definitive proof that these self-proclaimed Austrian "economists" aren't worthy of the designation.

  • SpontaneousOrder

    Dr. S –

    I do not agree with all your positions. I do not take aggregation, sticky prices, exchange equations, and national income accounting and these things lightly. Nonetheless, I've stopped caring arguing about it because I realize that I actually get paid to do mathematics – real money, by real people, in the real world, and far more I have no doubt than the people on here(not bragging just proving context) A lot of economists – so called – talk about math, they really don't know what they are talking about. Economics is the dumpster bin of glorified MBAs who couldn't do Phd mathematics. In any case, I've gone over all this before.

    However, that doesn't stop one from being interested in your ideas in general and other topics specifically, which I am. You spend an INORDINATE amount of time responding to and squabbling over tripe with teenagers, junior high students, hobbyist libertarian unemployed recently graduated baristas, and the rest of it. Do not get me wrong: I respect and applaud your communication with the public.

    However, Now,

    I am over it.

    Please stop wasting your time on this blog and start writing new books. For your own sake. Please.

    Start by not responding to this post, nor any other post. Take a vacation. Turn the internet off. Time is passing you by. More research, less blogging.

    Thank you.

    • http://vikingvista.blogspot.com vikingvista

      The mathematics needed here are way below the level of a paid mathematician. And yet instead of just the history and economics tripping people up, it's the algebra.

      But I doubt a school can get much traction without persuading at least some of them. Seems like a blog is a perfect venue for that front.

      • SpontaneousOrder

        I don't think so. Look at Mises Institute and Joe Salerno in particular if you want: If there is a felt need to respond to an academic or otherwise intellectual point in the blogosphere or elsewhere he can publish a posting on his respective site and let commentators enjoy themselves; and instead of spending biblical and wasteful amounts of time and energy nitpicking with them, he offers through Mises Academy classes that people can pay a small fee for and learn his ideas at a more productive level. This also has the added benefit of weeding out those who are trolling and not really interested. His time is compensated, his energy is reserved, those who are interested gain further understanding, he avoids looking like a idiot responding to every 8th grader in the comments section. Joe Salerno and Mises Academy are very wise in this regard.

        A far, far better model in my estimation.

        I for one would pay for something similar and similar rates if Dr. Selgin, perhaps with Dr. White and scrounge up a few others would offer something similar.

        One would be remiss not to pay attention.

        This blog looks ridiculous. Mises.org looks professional. Pay attention.

        • http://vikingvista.blogspot.com vikingvista

          "This blog looks ridiculous. Mises.org looks professional."

          You lost me there. Those ridiculous commenters you are complaining about here, *live* at Mises.org.

          There is nothing peculiar about a blog post by one economist (Selgin) regarding the comments of another economist (Salerno). So your complaint reduces to not liking Selgin engaging the hoi polloi. So don't read the comments. I guarantee you the comments at Mises.org are an order of magnitude more absurd than most of what you'll find here. Actually, it's an order of magnitude of quantity of the exact same ridiculous arguments.

          Since the quantity (and definitely the quality) of Selgin's work is unsurpassed by anyone at Mises, this blog doesn't appear to be much of a distraction. If you prefer to see him engage only other economists, then perhaps you should check out his Cato appearances.

          • SpontaneousOrder

            Right. You make my point.

          • Rick Fitz

            I agree. The sheer condescension from VV made it clear she knows very little about the Austrian school.

      • Rick Fitz

        Math, without a proper underlying structure for measuring what it is intended to measure, is solipsism at the worst. Economics is the study of how man acts, not arcane BS about how the world SHOULD be structured, but an examination of how it IS structured. Your models are flawed.

  • Clearskys

    "Legal tender laws have nothing to do with fractional reserve banking. Nothing. They influence the choice of base money, not commercial bank reserve ratios."

    That's another way of saying what I said while disputing what I did not say. Legal tender laws affect the OUTCOME by eliminating competing currencies and with it the choice of quality of money substitutes that end up circulating as notes. Once monopoly of issuance is established, there can be only single quality. Since monopolies tend to reduce not increase product quality, the incentive to keep the quality of notes high goes out the window. Works well for central banking cartel, not so well for bank note holders who are stuck with uniformly low quality FRN's.

    Another severally diminished incentive is for maintaining either 100% reserve banking or different reserve fraction between different banks. Why should bank A maintain higher fraction than bank B when their notes are identical? Note holders can not readily distinguish between them, the product is in fact identical. Yes, banks can and do maintain slightly different reserves for other reasons but if they did so in order to make their own notes more attractive the reserves ratios would range between zero and 100%. FDIC further eliminates depositors incentive to distinguish between solvency status of each bank, which acts to effectively lower the reserve fraction.

    So while you are obviously correct to point out that legal tender laws are not prerequisite for fractional reserve banking system, absence of this monopoly is prerequisite for formation of competing bank notes that are allowed to be used as currencies, which is needed for proper market price discovery of what the reserve fraction should be, what interest rate should be offered to note holders to compensate for any given reserve ratio and possibly even what form the bank reserves should be held in as reflected by consumer preference.