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

Feet of Clay

I never thought it would happen–perhaps I'm slipping.  But as I was preparing to bang-out this post, my first in over a month here, I discovered that, a couple hours ago while I was toiling away in class, Paul Krugman stole my thunder.

Despite that bad omen, I'm plunging in with my two-cents, which, like Krugman's, has been provoked by an article in today's New York Times.  The article, which is mainly about Minneapolis Fed President Narayana Kocherlakota, who just recently rotated onto the FOMC, includes a quote from Ed Prescott, who is himself (among other things) a member of the Minneapolis Fed's research staff.  What Prescott said–and what put Krugman in high dudgeon–is: "It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed."

That's right: no effect–none, nada, zero, zilch–on output, or on employment, ever.  Not even in the 30s.  Or in the 70s.  Or recently.  Why, the Fed might as well set its policy targets by throwing darts at a board, for all the difference it would make to real activity.  Money's just a veil, after all.  We know that–what's more we know it "scientifically."

Krugman rightfully pours scorn on Prescott's assertion, which states a "scientific fact" only in the peculiar sense that distinguishes such facts from ordinary, unqualified, plain-old facts, that is, the sort of facts one might glean from experience.   A "scientific fact," apparently, is not such a grubby affair.  It is, rather, something much more pure, even virginal; it is a fact implied by a theory.  The theory in this case is of course the "real business cycle" theory for which Prescott (and coauthor Finn Kydland) are famous.  The theory starts with the New Classical premise that prices always adjust instantly to their general equilibrium levels, thereby all but eliminating any scope for real consequences of monetary disturbances.  It then proceeds–hey presto!–to the conclusion that, if real variables bounce around, they must do so in response not to monetary but to real shocks.   It follows, as a matter of logic, that the world economy must have met with a whale of an adverse supply shock in the 1930s.  What shock, you wonder?  What difference do such details make?  There had to be a big bad shock, dontchyasee: the theory proves it.   If the historians and econometricians can't find it, well, so much the worse for history and econometrics.

Some Austrian economists like to insist on the a-priori nature of their discipline, while many non-Austrians, myself among them, fault this sort of Austrian economics for its failure to to be swayed by experience.   But when it comes to dogmatic a-priorism,  even the most doctrinaire praxeologist can't hold a candle to some of the economics profession's perfectly mainstream superstars.

  • Paul Marks

    The monetary chaos (boom-bust-ism) promoted by the Federal Reserve since its creation in 1913 would have had an effect on American real output – a negative one (i.e. output is smaller than it would have been had the Federal Reserve not been created in 1913).

    The "National Banking Acts" (from the Civil War period) giving artificial advantages to the big New York Banks (for example forbidding other banks to engage in "discounting" their debt paper) would also have had a negative effect (reduced economic growth over time – made economic output less large than it otherwise would have been), but not so radical an effect as the Federal Reserve has had.

    For example, the vast increase in prices that has occurred since the foundation of the Federal Reserve in 1913 simply could not have happened under the old banking and monetary system (the banks could engage in credit expansion under the old system – but there nothing to back up the system when a crash, inevitably, occurred, so the credit expansion would tend to fall back towards the "monetary base" of cash). The Fed has made "booms" (credit expansion – lending that is not from REAL SAVINGS) bigger than they would have been under the old system – and has tried to support credit expansion, with monetary inflation (i.e. expansion of the monetary base itself).

    • Re the idea that “The Fed has made "booms" bigger than they would have been under the old system…”, there is not much evidence of that from the chart here:

      What stands out a mile is the 1930s depression and WWII. Apart from that, not much to choose between the old system and the new, I’d say.

      • "not much to choose between the old system and the new"

        Here's a somewhat different opinion.

      • In a lot of ways the pre-Fed and Fed systems produced pretty much the same outcomes if you ignore the Great D. so why the need for the Fed? But why exclude the Great D? It happened on the Fed's watch and no depression even remotely as bad happened under the quasi-gold standard. The Great D, the stagflation of the 70's and the Great Recession are major Fed fails, none of which happened before the Fed.

        Also, check out this paper from the Bank of England, Financial Stability Paper No. 13 – December 2011
        Reform of the International Monetary and Financial System by Oliver Bush, Katie Farrant and Michelle Wright. Here is an excerpt: "Table A below, which presents a range of summary statistics on the performance of different IMFS regimes, shows for example that the incidence rate of banking and currency crises in the Gold Standard was much lower than in today’s system.

  • Apologies if I'm asking the bleeding obvious or just plain off topic, but you are a "non Austrian" because…?

    • George Selgin

      Because belonging means conforming.

      • How unfortunate for the school that Austrian economics has congealed into something incompatible with free banking and George Selgin. I suppose that means the "banking is fraud" coup d'etat has succeeded. Clear thinking doesn't always prevail.

        Perhaps it is the fate of any named school that it ultimately encompasses and stagnates around an absurdity. Makes me wonder what is in store for the Free Banking school in 100 years.

        • See my post below. It's possible that Murray Rothbard took the movement in a wrong direction. I have never liked his "advancement" of natural law. I think it is more of a regression. And it's possible, based on the paper I mention, that he distorted Mises' a priorism.

          Austrian econ agrees with mainstream, even Keynesian, on most issues, especially the basics. Austrian micro is very little different from mainstream. In macro, the Austrian difference comes in it's more robust capital and monetary theories. I consider Selgin to be Austrian based on his monetary theory.

          • "It's possible that Murray Rothbard took the movement in a wrong direction. I have never liked his "advancement" of natural law."

            I'd have to presume what Professor Selgin meant by "conforming", and he appears to be criticizing at least some application of apriorism, but I expect it goes beyond respectable nuanced intellectual fundamentals. You can respect some approaches to economics based upon Natural Law, and you can respect some that aren't.

            But how do you respect the belief by an economic school, e.g., that an interest-bearing loan to a bank is a fraudulent storage device? Or that a fractional reserve bank characteristically maintains total deposits that are less than total loans? Or that the classic money multiplier is the simple result of a bank receiving a deposit and issuing multiples of that deposit in loans? Or that a time deposit is categorically different from a demand deposit, rather than a difference along a continuum? Or that a bank default is fraud?

            These aren't approaches or theories. They are errors, plain and simple, some semantic, some historical, some arithmetic. How can an economic school embrace such errors end expect to have much of a future?

          • Good points. But I don't see those types as defining Austrian econ. They are a vocal and often offensive segment because of their supposed moral superiority, but I'm not sure they're the majority and should not be allowed to define the school. Maybe I'm old fashioned, but I still define Austrian by Hayek and Mises. Rothbard's economics is great, outside of his misdirection of Mises' a priorism. But I think his ethics belongs to politics, not economics.

          • I know what you mean by "those types", and it would truly be unfair to attribute many of their grossly misguided economic claims, many of which are crass misrepresentations of Mises, to any self-described Austrian economist. Still, I'm not sure why Hayek or Menger can't be the characteristic Austrian, rather than Rothbard or Mises. In particular, I'm discouraged and puzzled by the following quotes, both of which fairly fuel "those types":

            "Let’s see how the fractional reserve process works, in the absence of a central bank. I set up a Rothbard Bank, and invest $1,000 of cash (whether gold or government paper does not matter here). Then I “lend out” $10,000 to someone"


            "Circulation credit is credit granted out of funds especially created for this purpose by the banks. In order to grant a loan, the bank prints banknotes or credits the debtor on a deposit account. It is creation of credit out of nothing. It is tantamount to the creation of fiat money, to undisguised, manifest inflation."


            I think the two views are consistent with one another, and I can't help but conclude both men were in agreement. And although Mises's notions of "circulation credit", "fiduciary media", etc. seem at first glance to correctly describe the products of banking, after a little attempt at clarification, it turns out the concepts are contradictory.

            Honestly, when it comes to banking, Mises's (and subsequently Rothbard's) writings should be completely scrapped and considered unsalvageable. I love Rothbard and Mises for other reasons, but their views on banking are nonstarters.

          • Yeah those are unfortunate ways of describing the process. But I take it as shorthand in place of a lengthy description of the process. I know Mises and Rothbard understood how banking works. For example, when we say the Fed "prints" money, we know they don't. It refers back to a time when banks could actually print more money to loan out. But the effect is similar to printing money.

            As Hayek described it in "Monetary Theory and the Trade Cycle," banks merely loan out a portion of deposits, but the effect on the total money supply is the same as if they created credit ex nihilo or printed a bunch of money to loan out. He added that it's impossible to get rid of all fractional banking because life insurance companies and many others do it. It's not just a banking issue. (The Dutch Republic had business cycles without fractional reserve banking that were due to an expansion of credit through pyramids of bills of exchange.)

          • "I know Mises and Rothbard understood how banking works."

            Even in the face of evidence to the contrary?

            "As Hayek described it … the effect on the total money supply is the same as if they created credit ex nihilo or printed a bunch of money to loan out."

            If true, then my discouragement with the Austrian school is complete. How can an economist elaborate so eloquently upon the information problem, and also think that the re-lending of basic money is the same as issuing of redemption promises unrestrained by basic money? One is truly worthy of a Nobel laureate, while the other is not befitting an economics freshman.

            I was initially attracted to the Austrian school for their supposed free market principles. But as the economic errors build up, at some point the question must be asked, "Are Austrians cranks?"

          • The quotes you provided are not evidence. You have to read much more of their works to get the full picture and you have to use sound hermeneutical principles in interpreting what they wrote, the main principle being the context. Have you read Mises' "Theory of Money and Credit" or Hayek' "Monetary Theory and the Trade Cycle"? I doubt you can say they don't understand banking.

            What is the basic point of free banking? Is it not to restrain the growth of credit through banking competition? But why restrain the growth of credit if it causes no harm? Free banking strives to restrict credit expansion because credit can grow too fast and cause problems, but what is the standard against which credit grows too fast? In other words, what measure tells free bankers that credit is growing too fast? If credit can't grow too fast then what is wrong with central banking?

            BTW, Hayek endorsed free banking in his later days because he saw it as the best method for restraining credit growth. Credit grows for one reason. You can say that banks create money to loan, or you can say that they loan money from demand deposits. If you say they loan money from demand deposits, then you have to acknowledge that two people have claim to the same money. It's just a matter of perspective for describing the same thing.

          • McKinney,

            “The quotes you provided are not evidence. You have to read much more of their works to get the full picture”

            I’m a bit confused here. Did you not see that I provided links for the quotes? Or are you expecting me to post in a blog comment the entirety of what I have read? As for Rothbard, if you can succeed where I have failed, and can find in a greater context a way to make what he wrote in that quote correct, I should very much like to see it. The trouble is, Rothbard’s greater context is an elaboration and reinforcement of that error.

            Mises is different. His ToMaC certainly isn’t the rantings of incoherent rothbardian drivel that you hear from the vast majority of his defenders in Internet forums. But for all of its brilliant insight, in describing the fundamentals of banking and credit the ToMaC makes at least one subtle error, which essentially amounts to Rothbard’s more obvious error. Mises fails to see that his notion of commodity credit does indeed entail his notion of credit expansion, even while he claims it doesn’t. The reason I believe he fails to see that commodity credit can be expanded, is because he restricts lending considerations to money substitutes, rather than considering the direct lending of money proper–a consideration which sheds light on his error. But essentially, this is the same misunderstanding of credit expansion that the worst of the rothbardians suffer.

            ‘Have you read Mises' "Theory of Money and Credit"”


            “Hayek' "Monetary Theory and the Trade Cycle"?”

            No. But that is why I was taking your word for it that Hayek mischaracterized banking.

            “What is the basic point of free banking? Is it not to restrain the growth of credit through banking competition?”

            No. Free markets do regulate and stabilize behavior, but the purpose of free banking is to increase the efficiency of distributing savings. The natural regulatory mechanisms that occur when individuals are not restrained from such practice provide the signals necessary for a distributed network of lenders and borrowers to act toward that efficient end.

            “But why restrain the growth of credit if it causes no harm?”

            It doesn’t cause harm. Bad loans cause harm. If the loans are sound, there really is no limit to how many levels of indirection of savings there can be. Allowing free competition provides the signals necessary for more sound loans to occur.

            “Free banking strives to restrict credit expansion”

            I could be wrong about the Free Banking school (who am I to say?), but how many times have we heard that under free banking, reserve ratios were very very low? The purpose is NOT to restrict credit expansion. The “purpose” (rather the effect) is the better management of credit expansion.

            “then what is wrong with central banking?”

            The signals, of course. Central banking with less credit expansion does worse than free banking with more credit expansion.

            “Hayek endorsed free banking in his later days because he saw it as the best method for restraining credit growth.”

            There is another very disappointing fact about Hayek. As before, I take your word for it.

            “You can say that banks create money to loan, or you can say that they loan money from demand deposits.”

            Yes, you can say both, just like you can say “apples or oranges”. They are quite different things. Really, just follow the trades, and you can’t help but see.

            “If you say they loan money from demand deposits, then you have to acknowledge that two people have claim to the same money.”

            ONLY in the sense that EVERY debt (of x) of every sort in any context means that two people have claim to the same x. But I don’t think this is what you mean.

          • McKinney,

            I’ve had a chance to read Hayek’s “Monetary Theory and the Trade Cycle”. Thanks for recommending it.

            I think you are mistaken when you say,

            "As Hayek described it … the effect on the total money supply is the same as if they created credit ex nihilo or printed a bunch of money to loan out."

            After Hayek correctly describes the money multiplier, on p162-3 starting with “What has been said above…”, he explicitly (and again correctly) mentions an important way the two practices you describe are in fact *different*. The difference he describes would obviously have profound effects on the money supply.

            I don’t see Hayek in this book specifically making the Rothbardian or Misesian errors on banking.

            However, what is surprising for Hayek, is that he:

            1. Merely describes the a depositor’s use of his account as the “root of the bank’s ability to create purchasing power” (p165), without a hint toward the facts that:

            (1) a person typically deposits specifically to save, NOT immediately spend;

            (2) interest on deposits are an incentive to save,

            (3) unless the spent funds are deposited into the same bank (or a coincidental deposit made, which Hayek earlier does refer to), a restructuring of the credit network must proceed very much as if the deposit was withdrawn as cash and then re-deposited elsewhere.

            (4) bank’s reserves necessarily account for their history of short-term deposits so that if depositors were in the habit for some reason of only briefly depositing before spending, reserves would be higher to allow for this. This reduces credit expansion much as if no deposits were made at all, in spite of the fact that all consumption spending is occurring by check without cash withdrawals.

            So although Hayek writes nothing untrue, his omissions lead the reader into thinking this is all extra money in circulation being used like high velocity cash–which, of course, is highly inaccurate. The reality, is that extent of credit expansion (in competitive commercial banking) most reflects the extent to which savings is redirected to better (i.e. more stable and more profitable) uses. The elasticity Hayek refers to is really due to the ability of the banking system to redirect savings to better uses.

            2. Hayek believes (p175-6) that during the early recovery, the increased quality of the available borrowers permits a decreasing reserve ratio without increased bank risk, which is the source of credit expansion, which results in a bidding up of capital goods (including labor), which leads to increased cash withdrawals by workers for consumption spending. He believes this depletion of reserves triggers a halt to credit expansion, a rise in interest rates, and finally “render unprofitable … those investments which were created with the aid of additional credit.” (p176). This is how a private commercial fractional reserve banking system allegedly is an endogenous source of the inevitable trade cycle.

            The problem? He ignores the fact that such capital investment (if market directed) increases productivity, thereby reducing prices, thereby allowing worker’s increased consumption with LESS cash, and permitting expected real profits even with decreased nominal profits, and obviating the need for early boom entrepreneurs to predict later interest rate increases.

            Hayek may be correct if capital allocation is systematically wasteful, but then he must allow for an exogenous cause of that systematic error (e.g. central banking interventions p145, “short period variations in climate”, or “sudden appearance of entrepreneurs of genius” p185). It seems he has not succeeded in identifying an endogenous cause of the trade cycle, since his theory requires the unlikely coincidence of widespread unproductive loans in the absence of a coordinating exogenous shock.

            Hayek does allude to this mitigating issue of increased production in the text on p217 without an accounting, and in a footnote on p215, saying it “needs further elaboration”. I should think so. Especially since he essentially grasped the notion elsewhere (e.g. Hayek’s “The Paradox of Saving”, which Hayek himself references).

            It is not credit expansion that is a problem, but too many bad loans. On the contrary, since credit expansion in a free market is the shuffling of savings to ever better borrowers, any imposed limitation on credit expansion results is a LESS stable and LESS productive condition.

        • Paul Marks

          I have no objection to Free Banking – as long as what is meant that anyone is allowed to be a money lender.

          Lending real savings (one's own savings, or the savings of other people voluntarily entrusted to be lent out – on the understanding the saver does NOT have the money after it is lent out, till when and IF the loan is repaid) should be what the banking business is about. It should not be about creating credit bubbles.

          However, if someone insists on lending out money that they do not have (indeed does not even exist) then they should be allowed to go bankrupt. No "suspension of cash payments" or other "legal" trickery.

          As for George Selgin (or anyone else). No human being has magical powers – if REAL SAVINGS are one billion Dollars, then lending can not be greater than one billion Dollars, without a credit bubble. And all such bubbles burst.

          One is indeed free to jump off a roof – but one is not free of the law of gravity.

  • Unsal Cetin


    I think that "the New Classical premise that prices always adjust instantly to their general equilibrium levels, thereby all but eliminating any scope for real consequences of monetary disturbances" holds true only if there is not any price and wage rigidities at all. But we know that they exsist and therefore monetary disturbances have real consequences. Best possibility is, in the long run, their ineffectiveness. Hence Ed Prescott's claim that "monetary policy has had virtually no effect on output and employment". But there exsist, I beleive, much more serious effects, especially when monetary policy leads to discoordination of interest rates and does not take into account the productivity norm. So can not we say that the Fed may have detoriated the efficiency of "output and employment" in the US?

    • George Selgin

      Of course I agree with you, Unsal. But bear in mind that Prescott's position isn't based on any empirical evidence regarding the extent of price rigidities; it is based on the New Classical belief that any appeal to such rigidities amounts to a denial of utility-maximizing behavior, and is therefore inconsistent with the microeconomic fundamentals.

      To me this argument is nothing more than a transparent non-sequitur. Nevertheless many economists find it perfectly convincing, and so are not inclined to be swayed by contrary empirical evidence.

      • Unsal Cetin

        I see you Selgin. And price and wage rigidities is just one side of the real story. The one with deflationary effects. We may mention on the other side too. Cantillion effects which lead to formation of asset price bubbles. And this effects also play a role that falsifies sudden and proportional movement of monetary excesses.

        Certainly there are non-monetary (real) factors that support asset bubbles and deflationary pressures. But monetary factors are main thing in this story. So, the "real business cycle theory" seems a little ironic to me since it is so far away from reality.

        • Paul Marks

          Wage rigidities (caused by government regulations, such as those giving power to unions) explain unemployment – but they do not explain "deflation".

          A massive "deflation" must mean some form of contraction of the money supply. So then the natural question is what sort of money supply is contracting?

          Talking of "changes in the velocity of circulation" (as some do) is really a dodge. Normally it is bank credit ("broad money") that is contracting – i.e. credit bubble collapse ("money" that was not real savings).

          None of the above should be held to imply that wage rigidities are unimportant – on the contrary the government intervention (under both Hoover and Roosevelt) that created wage rigidities, is a major reason why the outcome of the 1929 bust was so different to the outcome of the 1921 bust.

          I repeat.

          Such terms as "needs of trade" (the mantra of the early 19th century Banking School – to justify lending out "money" they did not really have), "sensible credit expansion", "reasonable credit expansion", "credit expansion done right" and Central Bank bailouts in return for "good securities", are waffle.

          Throwing in equations (the pretend science of mathematical "economics") does not them any less meaningless.

          • Unsal Cetin

            I know that deflation (The Bad One) is secular contraction of money supply. If there is no instant adjustment of prices and wages, contraction creates bad deflation. But if prices adjust instantly and proportionally, then we would not have a deflation. Economic actors create new money balances. Wage and price rigidities are what turns simply a monetary constraction into a bad deflation so long as central bank does not follow the original Bagehot Rule.

  • Thanks for the insight into the real business cycle theory. Scott Sumner wrote in a post at Econ Lib that prices adjust instantly and I was wondering where in the world he got that idea. Very strange.

    On a priori economics, have you read THE EPISTEMOLOGICAL IMPLICATIONS OF MACHLUP’S INTERPRETATION OF MISES’S EPISTEMOLOGY by Gabriel Zanotti? Essentially, he says that Mises' a priori is no different than that of any other science, although other sciences try to hide their a priori assumptions. Here is the abstract:

    We argue that Machlup's (1955) interpretation of Mises’s epistemology is at least, if not more, plausible than Rothbard's (1957). The implications of Machlup’s interpretation of Mises and Austrian epistemology affect Austrians, non-Austrians and how they relate to each other. Machlup’s interpretation shows that Austrian’s epistemology is well grounded and that most criticisms of Austrian economics based on their aprioristic characteristic are misplaced. Furthermore, Machlup’s interpretation provides a potential road to re-built the academic interaction between Austrians and non-Austrians that was characteristic of the early twentieth century.

  • Paul Marks

    vikingvesta – of course it is not a matter of Natural Law in the sense of ethics (at least not at first – see later), but it is in the sense of REASON (the old idea of what "logic" means – before logic just became a matter of mathematics and so on). Rothbard (like Carl Menger) demanded that things make-sense, rationality mattered to him. That does not mean that Rothbard was always correct – but demanding that things make-sense (are rational – are logical, in the old sense of the word logical) is the correct approach.

    For example, lending must be from REAL SAVINGS (the sacrifice of consumption). If total REAL SAVINGS are (for example) one billion Dollars lending can not be two billion Dollars – unless there is "credit expansion" (credit BUBBLE building). Reason dictates that lending must not be greater than real savings – and to call credit money expansion "savings as real as any other form of saving" (as Lord Keynes did) is dishonesty.

    Of course that does lead as back to ethnics – economics may be scientific and "value free" (as Ludwig Von Mises wrote), but science itself depends on certain ethical principles, for example RESPECT FOR TRUTH. If someone is just prepared to pretend that credit expansion is "saving" then they have no respect for truth (no honesty) and the economics they produce will have no value.

    See Hunter Lewis "Where Keynes Went Wrong" for the rejection of morality (including truthfulness) by Keynes and his friends.

    • Paul,

      Credit expansion being simply a measure of the number of redirections of savings–the extent to which the indebted iteratively save rather than consume their borrowings, it is odd that someone like Rothbard, so committed to the "logical", "rational", and sensible, should struggle with this rather simple and accessible reality; just as it is odd that someone with "respect for truth" should lie about how banks expand credit (is it possible to believe that any PhD economist could get the basics so wrong?); just like someone so committed to "ethical principles" should engage in unmitigated calumny ("fraud!") against those engaging in this perfectly peaceful, legitimate, productive, and thankfully well developed activity.

      But then again, it is more common than odd that the greatest sanctimony emanates from where it is least deserving.

    • George Selgin

      Paul, you should cut back on the all caps–its the print equivalent of shouting, and its effect, if you ask me, is to subtract rather than add to whatever force your arguments might possess. The same goes for your habit of insisting that anyone who disagrees with your views is dishonest, and immoral, and lacking respect for truth, etc., etc.

      As for the substance of your arguments, there is no merit to it: I devote several chapters of Theory of Free banking, toward explaining at length precisely the point that expansion of lending, and of the money stock (whether fiduciary or not), in so far as it serves to offset a decline in V, is indeed based on "real saving," in the sense of abstinence from spending. How else, do you suppose, that V can decline unless it is because people are seeking to accumulate monetary assets and, hence, are choosing to refrain from either consuming or acquiring other assets?

      The truth is that it is the Rothbardians themselves who don't seem to appreciate what is required to keep the extent of bank lending consistent with the extent of real saving via the banking system.

      Besides making the arguments at length in my first book, I and others have repeated them tirelessly here and elsewhere, only to have 100-percent types come back with the same old assertions, capitalized or otherwise. It's like taking to a bunch of brick walls, and to that extent utterly unrewarding. But then, there is always some chance that someone exposed to the Rothbardian position, but still capable of entertaining criticisms of it, is reading these exchanges. It's for that reason, and not because I imagine ever changing the mind of a Rothbardian true believer, that I'm willing to recover the same ground again and again.

      • Paul Marks

        Very well George I will not use capitalisation (bold and italics appear to be unavailable).

        As you know quite well, the basic purpose of credit expansion is to increase lending beyond real savings (to lend more than real savings – to create a credit bubble).

        That you choose to pretend otherwise is your choice (not mine). But what you imply is not true – and you know it is not true.

        Good day to you.

  • Paul Marks


    Do you work in the financial industry? If so this would explain your position that one can lend out money than has really been saved (as you know the whole point of "credit expansion" is to lend out MORE money than has really been saved, saving being the sacrifice of consumption, – to lend out money that does not really exist). You can only do this by creating a credit bubble – and all such bubbles burst.

    To describe credit expansion as the "the number of redirections of savings" reminds me of the old story of three men ship wreaked on an island.

    After some weeks they are rescued by a passing ship (USS Bailout), the three men are starving to death (as none of them actually produced anything whilst on the island – they did not farm or anything), but the three men are happy as the claim they are now very rich.

    "You see one of us had a hat – and we have this sold this hat thousands of times amongst us, we now have thousands of hats each!"

    Why do you think bankers (and other such) always complain of "deflation" a "fall in the money supply" after a bust? Say after 1929?

    Did evil deflation elves break into their vaults and steal the money?

    No there are no elves – and the money WAS NEVER THERE it DID NOT EXIST.

    It was CREDIT EXPANSION – not money.

    That is your "number of redirections of savings".

    • Paul,

      “Do you work in the financial industry?”

      The odd thing is, it doesn’t require an advanced degree or experience in any particular industry to grasp that you are in error. Really, the ability to simply follow the trades between individuals and mentally extrapolate to a larger system should be accessible even to an average high school student, with just a bit of concentration. That is probably why high school economics textbooks include descriptions of the money multiplier. But why does it elude you?

      “If so this would explain your position that one can lend out money than has really been saved”

      I don’t know what you think my position is here. I suspect a typo.

      “as you know the whole point of "credit expansion" is to lend out MORE money than has really been saved, saving being the sacrifice of consumption, – to lend out money that does not really exist”

      Nobody, including myself, “knows” that. Some people do indeed unfortunately *believe* that. A similar but correct statement in this context might be simply “credit expansion is lending what has been saved”. But it is lending out basic money–i.e. money that exists. Surely you know (or maybe not) that the entire textbook money multiplier can be explained with no transactions but the lending of gold coins–i.e. where every single transaction involves one person physically handing over shiny yellow gold coins to another person. It requires no printing of money, no counterfeiting, not even circulating bank notes. Credit expansion requires ONLY the lending of basic money.

      “You can only do this by creating a credit bubble – and all such bubbles burst.”

      That is the same as saying “all loans fail when made by the indebted”. It is an amazing belief to have. If you think hard about it, I think you will eventually agree that it really is possible for you to be in debt, and also to make a sound profitable loan. In fact, that is how the modern banking system efficiently allocates savings to more productive uses. Information limitations mean that such allocation requires the money to pass through many hands. And that is your credit expansion.

      “To describe credit expansion as the "the number of redirections of savings" reminds me of the old story of three men ship wreaked on an island.”

      The story I heard was a bit different…

      Man #1 discovered a way to catch fish from the sea, but to do so he needed bendable wires that were only to be found in the clothing of man #2. Neither man #1 nor man #2 were aware of each other’s mutual usefulness.

      Man #3, on the other hand, knew the entire story. He knew he could borrow the wires from man #2 in exchange for future fish, and then loan those wires to man #1 in exchange for even more future fish.

      However, man #3 was a Rothbardian, and he “knew” that if he did this, the resulting ‘moneyfromnothing’ credit expansion boom would collapse, so he kept his mouth shut.

      When the ship arrived, all three men were dead from starvation. The corpse of man #3 had a wide grin–he died knowing he defended Rothbardian “sound” money practices up to his last hunger pang.

      “Why do you think bankers (and other such) always complain of "deflation" a "fall in the money supply" after a bust? Say after 1929?”

      Uhh…because bankers don’t like their loans to fail? Are you suggesting that someone out there *likes* bankruptcy?

      “Did evil deflation elves break into their vaults and steal the money?”

      Steal what money? Their loans failed. That is, after all, a risk with any loan. What is so hard to understand about this?

      “No there are no elves – and the money WAS NEVER THERE it DID NOT EXIST.”

      Of course the money was there. It was there, and then it got loaned out, and then the loans defaulted. This is not rocket science.

      “It was CREDIT EXPANSION – not money.”

      Correct–credit expansion is not money. And digestion is not food.

      • Paul Marks

        Vikingvesta – sadly I am not in error.

        Credit expansion (whether by the complex interplay of private banks – or by Central Bank intervention) is an effort to lend out more money than has really been saved – in order to achieve "lower interest rates".

        To talk (as some do) of this credit expansion being "based on" real savings misses the point – the point that the amount of "money" being lent out is greater than real savings.

        As for your claim that no real monetary expansion is cause by credit expansion.

        You are both right and wrong.

        You are right in that no more real (real) money need be involved (no increase in the "monetary base") – however the whole point of credit expansion is to increase "broad money" (the credit bubble).

        I ask you (yet again).

        If there is no increase in broad money via credit expansion (credit "money" being what "broad money" is) then how do you explain the depairiing cries of "deflation" after 1929?

        No one was going round burning Dollar bills in bank vaults and melting down coins in those vaults.

        What fell was bank credit ("broad money") – i.e. the credit expansion you say does not exist.

        Sorry but it is not just the "redirection of savings" – it is the lending out of "money" that was never really saved (money that does not really exist). This creates a credit bubble – and all such bubbles must burst.

        Then despairing cries of "deflation" are heard – from the very bankers who created the credit bubble in the first place.

        And, no, just getting rid of Central Banking would not prevent the creation of banker credit bubbles (the "expansion of broad money") although it would radically reduce their size.

        Boom-busts would still occur (bankers, via the complex interactions between banks and the terrible accounting practices of banks [pretending that "depositors" still have money that has been lent out – and writing of "crediting to the account" rather than "lending money") – but (without intervention) the "boom" (the credit-money expansion) would tend to collapse back towards the monetary base during the "bust".

        "Credit expansion" (the word "correct" is as foolish as the "needs of trade" nonsense of the "Banking School" in the early 19th century) may not be "money" – but it is treated as money (and that is not an accident – bankers present their credit bubbles as if they were real money).

        That is why one has the (phony) "boom" – and it is why there are screams of "deflation" during the bust.

        • I do a complete specific point by point reply to your post, then you reply a repetition as though I posted nothing at all. Your inability to provide counterpoint should lead you to at least question the clarity of your understanding. Since you are unable to advance the discussion, it appears we are done. Have a good day, Paul. Thanks for your time.

          • Paul Marks

            Many thanks for your kind wishes vikingvista – I also hope you have a good day.

            I have written other comments (on this and other threads), but they have not appeared (and there is a limit on how many times I am willing to repeat myself – if something is in a comment that has not yet appeared I will often not bother to write it all out again).

            If you think you have shown how credit-money expansion (so called "broad money" expansion)does not lead to a boom-bust, I am afraid that I simply do not agree with you (do not agree with you on a fundamental level – it is not a matter of point-by-point details).

            In this world credit-money expansions (banking credit bubbles) have always led to boom-busts.

            Also I repeatedly hear complaints about the dangers of "deflation" from bankers (on CNBC, Bloomberg and so on) even though no one is threatening to burn currency or melt down coins.

            So am I being unreasonable to assume that even the bankers themselves do not agree with your (vikingvista) suggestion that credit expansion is not really "broad money" expansion?

            They (the bankers) seem to regard the credit bubble as monetary expansion – and regard any threat to the credit bubble as "deflation". And from 1929 onwards (as the credit money expansion of the late 1920s collapsed) prices did indeed fall – which by their own, Irving Fisher, definition was "deflation".

            The boom-busts before the creation of the Federal Reserve show that bankers are quite capable of expanding credit beyond real savings (i.e. creating a credit bubble)without any government Central Bank even existing – although on a much more modest scale.

            If there is any error in the above (or in my other comments) I will happily correct it – but what you have written does not point to any error.

            I repeat that saying that credit expansion is "based on" real savings misses the point (I believe deliberately misses the point) that the purppose of credit expansion is to lend out more "money" than was actually saved (i.e. to create a credit bubble).

            Also to say that credit expansion is not "really" "broad money" monetary expansion is simply counter factual.

            It is counter factual as, if this idea was true, the "boom" of the late 1920s would not have occurred and the collapse in prices after 1929 would not have happened – if the credit money expansion was just "the redirection of savings" (supposedly mistakenly counted many times).

            Your (vikingvista) theory that credit expansion (i.e. the expansion of "broad money" so that it is larger than the "monetary base") does not really happen (that it is simply a misunderstanding – the "redirection of savings" mistakenly counted multiple times) is not just inconsistent with evil "Austrian School" theory – it is inconsistent with the falling prices one sees in a bust (such as after the bust of 1929).

            I actually agree with you (I repeat – I agree with you) that the credit bubble stuff of bankers (the weird accounting practices and so on) is not really money – the "bust" shows it is not really money. However, it is treated as money – it really is, and that is because the bankers present it as if it was money.

            I really do not see why I should be blamed (by either yourself or George Selgin) for what I have never done. It is not me who creates these credit money expansion bubbles – these boom-busts.

            If you wish to get angry with someone – get angry with bankers who are not content to be ordinary money lenders (there is nothing wrong with being an ordinary money lender – either of one's own money or in the real savings of other people, as long as these other people agree to losing their money in the hopes of being paid more money later when, and if, the loan is repaid), and insist on being "credit expanders" (bubble blowers). And get angry with the Central Banks who encourage these bankers (and push them further and further) in their harmful activities – see (for example) Thomas Woods "Meltdown" and Hunter Lewis "Where Keynes Went Wrong".

            Almost needles to say…….

            All government interventions makes this problem worse – not better.

          • Paul,

            It is curious that you would think a repetition of your old points and of your mischaracterizations of my opinions would be interesting to me.

            Perhaps I should've pointed out early on, that there is no point considering money substitutes or other types of circulating debt until you first correct your erroneous belief about the nature of credit expansion (which the usual money multiplier explanation makes clear). To do otherwise would be to heap confusion upon confusion. A debt doesn't need to circulate for a central bank (and most everyone else) to label it as "money". It merely needs to be a debt of the bank. Until you understand that, your criticism is akin to the medieval Christians who simply hated debt.

            But if you should ever be interested in a discussion, I'll await a counterpoint to my earlier response.

  • Paul Marks

    If the expansion of bank credit does not expand "broad money" then there is no difference between the size of "broad money" and the monetary base, and (for example) no "decline of the money supply" after 1929 could have taken place (after all no one went around burning Dollars bills or melting down coins – it was "broad money", bank CREDIT, that was shrinking).

    It is not just the "bunch of cranks" Austrian School who understand this point, it is "mainstreamers" also. So to say that the expansion of bank credit does NOT expand "broad money" (make it bigger than the monetary base – the real savings) is just wrong. If it was not wrong there would have been no "broad money deflation" after 1929 and no fall in prices.

    The difference of opinion is not over whether credit expansion happens or not (no one believes it is just "redirecting savings"), the question is "is this a good thing or not" – and that is where the Austrian School and the "mainstream" take different positions, not over whether it happens but over whether the consequences are (on balance) positive or negative.

    This leads to different policy recommendations.

    The "mainstream" advice when a credit-money bursts is that the government should step in (via the Central Bank) to bailout the key financial players (not the little guys of course – they go to the wall) in order to "prevent deflation". This policy advance is based upon the idea that the "broad money expansion" (the expansion of bank credit beyond the monetary base – beyond real savings) was a good thing, and needs to be preserved.

    The Austrian School advice is to let the bubble (which is how we see the "broad money expansion") burst – and allow the banks and other such (the Goldman Sachs and the Warren Buffett) to go bankrupt – really go bankrupt (close their doors).

    It would be expected that someone who works in the Financial industry would not like the Austrian advice – after all it is hard to go from a well paying job (in credit bubble finance) to the nasty real world of cleaning toilets or picking up litter. I understand this and I do NOT condemn it.

    However, it need not mean poverty for ever. For example when the Gotch family owned bank went bankrupt in my hometown of Kettering, Northamptonshire (England) in the 19th century (the Bank of England, in those days, did not follow the Walter Bagehot advice to bailout banks) two of the sons (who would have been bankers had the bank been bailed out) became an architect and a painter. I think that Alfred Gotch was a good architect and Thomas Gotch was a good painter – and it was a good thing that they did not spend their lives blowing banking credit bubbles instead.

    However, when the family bank went bankrupt I doubt that someone like me ("you should get no bailout – let the place close its doors!") would have been wildly popular.

  • Paul Marks


    If it is a "misconception" that expanding bank credit is expanding "broad money" then it is a "misconception" shared by every banker on the planet. After all it the bankers (not me) who present bank credit as money.

    And you still have not explained why, if expanding bank credit is not expanding "broad money", why a bust leads to a fall in prices. Well why did prices fall after 1929? If it was not the collapse of bank credit ("broad money) what was the reason that prices fell after 1929?

    Did evil deflation elves go around burning bank notes and melting down coins?

    Nor is it the case that bank credit only expands with the banking of the Federal Reserve (although in the case of the late 1920s Benjamin Strong pushed the expansion of bank credit with fanatical zeal – just as Alan Greenspan did in the years before the 2008 bust). As I have already pointed out (several times) bank credit expansions (boom-busts) occurred before the Federal Reserve even existed.

    If you (vikingvista) are correct – the credit expansion boom-busts before 1913 did not happen.

    They did happen – therefore you are mistaken.

    Expanding bank credit (over and above real savings) was treated as money (because it was presented as money) – it did lead to a "booms" and these booms led to "busts" when false nature of the "broad money" expansion became obvious (i.e. that it was credit expansion – not real savings).

  • Paul Marks

    I repeat (as yet again a comment is "awaiting moderation").

    Vikingvista – if credit expansion does not happen (if it is just a misunderstanding), if the "cranks" of the Austrian School are just producing "drivel" why did prices fall after 1929?

    Some form of money contracted – and it was not notes or coins, so what was it? If it was not bank credit ("broad money") what contracted? What was the "deflation"? What was the "fall in the money supply" that Milton Friedman (no Austrian) spent decades complaining about?

    M.F. complained about a "fall in the fall in the money supply" – yet Dollar Bills were not being burned in bank vaults and coins were not being melted down. So what form of "money" contracted?

    You have claimed (repeatedly) that bankers do not expand lending beyond real savings (that this is just a misunderstanding of bankers "redirecting savings" multiple times), but this is contradicted by the basic facts (not just evil "Austrian School" theory).

    And, I again repeat, that this (the expansion of lending beyond real savings by the interactions of banks) occurred even before the Federal Reserve was created in 1913.

    I agree with you that commercial bankers do not really create money – but the credit they expand is presented as money and treated as money, so when it collapses (which, unless the government backed Central Bank comes to the rescue, it must collapse) there is a "deflation". There is a "bust" to the "boom". Although on a more modest scale than if the banker credit expansion (what is called the expansion of "broad money") is not supported by a government backed Central Bank in the first place.

    By denying that credit expansion (the expansion of "broad money") even happens (by claiming that is all an innocent misunderstanding of bankers "redirecting savings") you (Vikingvista) are not just denying the Austrian School – you are denying the common experience of mankind.

    • "if credit expansion does not happen"

      Hey Paul, it looks like you mistakenly addressed these posts to me.

  • Paul Marks

    vikingvista you still have not explained why prices dramatically fell after 1929.

    Your whole theory is based on the idea that credit expansion does not really happen – that it is really just banks "redirecting savings" (not lending out more "money" than there actually are real savings) and your theory is contradicted by the historical record (not just after 1929 – but multiple boom-busts which you are unable to explain, many of which happened before the Federal Reserve even existed).

    Let me help you – you could play the "velocity of circulation changed" game, the "V" from Irving Fisher's MV = PT effort to make economics look like physics (shove in equations and it is "scientific", to people who regard the methods of the physical sciences as the only "science" forgetting the older definition of science as a "body of knowledge" with different methods being correct for different subjects).

    Of course Frank Fetter and Henry Hazlitt refuted Irving Fisher – but the establishment ignore that, so you can also.

    • George Selgin

      Paul, vague comments about the futility of attempts to make economics "look like physics" won't suffice to dismiss arguments couched in terms of the equation of exchange (or any other equation, for that matter) so far as the terms that the symbols are used to represent are given clearly defined meanings, and so long as the equation itself makes sense given those meanings. Such is the case with MV=PT. Nor is it the case that either Hazlitt or Frank Fetter ever refuted that equation. Fetter criticized Fisher's theory of interest, not MV=PT. And while Hazlitt did find fault with the equation, he hardly refuted it.

      You would have been a more solid ground, by the way, had you referred to Benjamin Anderson, who did indeed take direct aim at the equation in his book, The Value of Money.

      • Paul Marks

        George are you joining vikingvista in denying that there was an expansion of "broad money" (bank credit) in the late 1920s and then a decline after 1929? Are you going to join vikingvista in denying that bank credit expands at all (over and above real savings) and pretend it is just the "redirection" of savings?

        As for Irving Fisher – he was refuted by the bust 1921 (which he could not explain and was baffled by) and by bust of 1929 (which he also could not understand). The whole idea of "P" (a price level determined by some index) is misleading at best. So we do not even reach the "V".

        By the way – still defending Walter Bagehot? The man who helped undermine Classical Liberalism in the 19th century ("we should concede everything it is safe to concede" – liberalism turned from the effort to reduce the size and scope of government, to allowing government to expand as long as it was in a "reasonable" way), and pushed bank bailouts in a way that even disgusted the then Governor of the Bank of England.

        • George Selgin

          Paul, I should think my words express my meaning clearly enough. But as you are unsure, allow me to point out that I say nothing about the 1920s at all.

          As for MV=PT, which I do mention, in it P is not "determined by" an index of prices; P is an index of prices. The rest of your remark about Fisher being refuted by 1921, or 1929, or both, makes no sense. Yes, Fisher did not expect the market to crash in '29. But that has nothing to do at all with MV=PT.

          Your claims about Bagehot are extravagant even by your own, extravagant standards. Of course he was arguing for the Bank to lend more liberally during external drains. Of course the Bank didn't welcome his advice. But he also insisted that lending be done at high rates on good securities. This was, admittedly, advice that no central; bank has ever managed to follow. But hive the man his due: he also said that England would have been better off had it never allowed the B of E to gain its privileged status.

          • Paul Marks

            George I know perfectly well that you (like vikingvista) have repeatedly failed to answer my points (about the 1920s or anything else) at least you have not pretended to have replied "point by point".

            This is the reason I keep repeating the questions – because you are unable to deal with them. As for trotting out equations as if economics was physics – that was the fashion of the time (due to a view that only the physical sciences were valid in their methods – and that no other methods were "scientific").

            As for Walter Bagehot – what I said was (sadly) entirely correct. Although I should also have said (and failed to say) that compared to the mainstream of today Walter Bagehot was a saint. And you make a good point about his statement of opposition to position of the Bank of England.

            However, declines seldom happen all at once – and people such as Bagehot helped get the decline under way.

            By the way – if you think my dislike of Walter Bagehot is harsh, you have never heard me discus John Stuart Mill.

        • "joining vikingvista in denying that there was an expansion of "broad money" (bank credit) in the late 1920s and then a decline after 1929…join vikingvista in denying that bank credit expands at all"

          Maybe he wants to join you in denying that the Titanic sank, or in denying that Germans drink beer.

          You really should do stand-up.

          • Paul Marks

            Vikingvista your theory is that banks do not (not) expand credit beyond real savings – that they just "redirect" savings, and that evil Austrian School "cranks" misunderstand this in producing their "drivel".

            Are you now rejecting your own theory and admitting that banks (via the complex interactions between them) lend out "money" that does not really exist (i.e. they lend out more than is really saved – they engage in credit-expansion?

            Still at least you are not playing with mathematical aggregates (such as "the price level") and relying on "changes in the velocity of circulation" to obscure the truth.

          • "Vikingvista your theory is that banks do not (not) expand credit beyond real savings"

            But I was just countering your theory that the Punic invasion of Spain was not (not) the inciting event for the maoist Cultural Revolution.

  • Paul Marks

    "But I was just countering your theory that the Punic invasion of Spain was not (not) the inciting event for the Maoist Cultural Revolution".

    No you were not Sir.

    Now do you accept that lending expands beyond real savings?

    • "Now do you accept that lending expands beyond real savings?"

      Amusing how you ask a question as if you'd ever deign to consider the answer. But not nearly as amusing as watching you simultaneously burn a straw man while beating a dead horse. Such dexterity. Will you do it one more time? I'm in need of a pick-me-up.

      • Paul Marks

        Vikingvista I repeat the question.

        Do you accept that lending expands beyond real savings?

        • George Selgin

          Paul, your oft-repeated question can't be answered simply, because you say nothing about the sort of banking system you have in mind. Some arrangements, notably those involving currency monopolies, can expand credit beyond levels consistent with saving. In others that generally cannot happen. I cover this ground in great detail in Theory of Free banking, and I have reminded you many times of the fact that I have done so. Yet you never address the arguments I offer there, or similar ones I have offered in many other places in various replies to Rothbardian nonsense. Under the circumstances it is pointless for Vikingvista, or anyone else, to have to field the question, for even if they bothered to consider every contingency and to otherwise repeat every detail of the necessary reply, they would be right to fear that you would ignore what they have to say on the subject.

          I will offer one point, though, beside what I have to say elsewhere. This is that nothing could be more simple-minded that the assumption that any bank that holds fractional reserves must to that extent have lent "beyond real saving." To believe this is to display an utter lack of understanding of the role of a financial intermediary. It is tantamount, in other words, to assuming that, if A lends X to B, who in turn lends X-Y=Z to C, then total lending has exceeded "real savings" by Z.

          Perhaps you agree that the conclusion here is quite mistaken. But if not, then you are guilty of a very fundamental misunderstanding.

          • Paul Marks


            My oft repeated question is very simple, but I have explained the matter (many times).

            Yet you do not answer the question – you evade it.

            Saving is the voluntary choice to sacrifice consumption from income.

            If savers choose to lend out one billion Dollars in the hope of being paid back (with interest) at some later date, then there is one billion Dollars available to be lent out (not one hundred billion Dollars). Once the savers have lent out the money (either directly or via a third party – such as a "bank") they do not have the money any more – till when, and if, it is paid back.

            Any effort (no matter how clever and complex) to lend out more money than has really been saved is bubble blowing – and the bubble (unless government comes to the rescue with freshly created money) will burst. The "banking system" credit expansion will shrink back down towards the monetary base (the real savings).

            I am not slave of the late Murray Rothbard – indeed I have spent many years arguing against Rothbardians on many matters.

            But to call basic logic "Rothbardian nonsense" (if you are describing the above as "Rothbardian nonsense") is just silly.

          • George Selgin

            "you do not answer the question – you evade it."

            No I don't.

  • Paul Marks

    Very well then Sir – answer the question.

    Does lending exceed real savings?

    Do not give me a link to some piece of writing.

    Just answer the question.

  • Paul Marks

    I have now clicked on the link and it turns out it is to a book – a classic attempt to avoid answering a question, but talking about just about everything else.

    Are you deliberately trying to provoke me?

    • George Selgin

      Indeed, Paul: I am trying to provoke you to read my book, whose subtitle is, after all, "money supply under competitive note issue." I wrote it to address precisely the question you pose, among other related questions.

      I understand that you would rather not have to read the whole thing. So allow me to say that chapter 4 contains the material most directly pertaining to your question. That chapter builds, however, on the preceding ones, so I cannot guarantee that you will find its arguments fully self-contained. It also does not address how central banking changes things, which is the topic of later chapters.

      The point of all this is that your question isn't one that is satisfactorily answered by a simple yes or no. To say this isn't to be evasive. It is simply to recognize, as I said, that what is the case in certain types of monetary and banking systems isn't true of them all. It is also to acknowledge that merely declaring that a banking system doesn't lend beyond real savings isn't satisfactory: an explanation of why this is so, and especially of why it is so even despite the presence of fractional reserves, takes some doing. Since I have done it already in my book, you cannot reasonably expect me to do it all over again upon each recurrence of the relevant question.

      • Paul Marks

        George I have asked you (and your associates) a straightforward question.

        You have not answered it.

        You either do not know the answer, or (more likely) you do know the answer and are refusing to say.

        • George Selgin

          Now Paul you force me to say that I think you have fallen off your rocker, and I dare say that you won't find a single person in 1,000,000 who, reading this exchange, would hesitate to agree with me.

          • "you won't find a single person in 1,000,000"

            Count me among the 999,999. But in Paul's defense, even though he isn't interested in dialogue, he still puts on a good circus. Peanuts anyone?

          • Paul Marks

            Dr Selgin – accusing me of "falling off my rocker" is not answering my question (by the way more and more people could answer my question now, certainly a lot more than "one in a million" [a number you are taking from Keynes "The Economic Consequences of Peace" where Keynes suggest that only one man in a million can "recognise and diagnose" the caused of hyperinflation in Russia or anywhere else], – so the time of people like yourself is drawing to close).

            I have (repeatedly) asked a straightforward question. You then asked me to explain the question (even though I have done so before – again repeatedly). So I did so – yet you still have not answered the question.

            I am asking you whether in this banking system (or even in the one before 1913 if you want to talk about the time before the Federal Reserve) whether lending is expanded beyond real savings.

            That is a "yes or no answer" – although I did not in fact ask for a one word answer.

            If the banking system does expand lending beyond real savings (and it does – so the answer to the question is "yes") then it credits a credit bubble, and (unless the government – Central Bank intervenes) with a bailout of new money (new monetary base) then the bubble will burst – and the bank credit will shrink back towards the monetary base.

            Even the Governor of the Bank of England at the time of Walter Bagehot was making the case for "limited", "reasonable" bailouts in return for "good securities" understood this reasonably well – even if you claim you do not understand it. Which is why he (the then Governor of the Bank of England) opposed this bailoutism.

            If banks (in their complicated interactions) expand lending beyond real savings then a bubble is created – and this bubble will eventually burst. And government (or a government backed "private" Central Bank) should do nothing to stop this bust – i.e. it should let banks close their doors (and not reopen them – go "bankrupt").

            However, you (George Selgin) will not even clearly say that the banking system (the one that exists not – or the one that existed before 1913) expands lending (credit) beyond real savings.

  • Paul Marks

    Cetin – I agree that prices do not adjust at once or in exact proportion to a fall (or a rise) in the money supply. I am not an MV = PT man (I do not suffer from "physics envy" – and do not even get me started on concepts such as "the velocity of circulation").

    However, a sudden large scale contraction of the money supply will tend to have the effect of falling prices – and not just a sudden large scale destruction of notes and coins. If bank credit ("broad money") suddenly collapses one would expect to see a fall in prices – especially in asset prices (such as real estate and share prices) if that is where the credit money expansion had gone. Of course there will be no exact mathematical relationship – but in general terms it will happen.

    Unless there is a government intervention to stop it happening. For example, the Central Banks (both the Bank of England and the Federal Reserve) have increased the monetary base (entirely fiat of course) by several hundred per cent, yet bank lending (bank credit – "broad money") has hardly gone up at all. This was because the purpose of the expansion of the monetary base by the Central Banks was to prop up an existing credit money bubble (a vast one that is called "the financial system") rather than to create a new one.

    As long as the "banking system" does not pyramid on the new monetary base (as long as they just "sit on it") hyper inflation (i.e. "prices in the shops" going by every day) is not going to occur (unless government does something else…..).

    Yes (as Henry Hazlitt pointed out) there are psychological factors involved (inflationary expectations and so forth), but the underlying point is valid. If the banks remain in a "zombie" state – if they do not fallow the calls to "start lending again" (i.e. pyramiding again) then hyper inflation is unlikely.

    Although the entire "financial system" remains a unsafe building (due to derivatives and so on) which could collapse at any time.

    And rather than let the system collapse international governments may resort to even more desperate measures.

  • Paul Marks

    vikingvista – you say that I am "not interested in dialogue" as if "dialogue" was automatically a good thing.

    Actually, in this, your remind me of the Rothbardians you claim to despise. In relation to the Iranian "hastener" regime the Rothbardians (and many others) say that friendly discussion (what you call "dialogue") is automatically a good thing. They fail to understand that the followers of Mohammed are taught to regard deceiving infidels as an act of moral virtue, and they also fail to understand that to a "hastener" (i.e. someone who wished to bring about the return of the 12th or "hidden" Imam) nuclear war is not a bad thing, it is good thing (as it leads to the return of the "hidden one") even if they die in the process. Shia "hasteners" are not insane and they are not stupid (many are highly intelligent) – but they have certain beliefs, and these beliefs must be understood.

    An extreme example, certainly it is. But it does prove the point that "dialogue" is not automatically a good thing.

    Now you serve as the goon-squad for the boss.

    Some students play this role in a university (the bad sort of university) – laughing at the lecturer's jokes (no matter how bad the jokes are) bullying (verbally – they do not tend to favour an honest fight) any student who does not agree with the lecturer, and so on.

    In work (especially middle management) some people continue to carry out this role. Again using "humour" (the classic weapon of a coward) to support the people in influential positions and ridiculing anyone who suggests (for example) that borrowing vast sums of money and using it to buy a loss making enterprise might not be a good move for the company.

    I will ask you the question again.

    Does the present banking system expand lending beyond real savings?

    I will not get an honest answer.