Sumner and Glasner on the euro crisis

Recently the Market Monetarist bloggers have come out with a number of comments on the euro crisis. It’s a joy reading them – despite the tragic background.

Here is a bit of brilliant comments. Lets start with Scott Sumner:

“Many people seem to be under the illusion that Germany is a rich country. It isn’t. It’s a thrifty country. German per capita income (PPP) is more than 20% below US levels, below the level of Alabama and Arkansas. If you consider those states to be “rich,” then by all means go on calling Germany a rich country. The Germans know they aren’t rich, and they certainly aren’t going to be willing to throw away their hard earned money on another failed EU experiment. That’s not to say the current debt crisis won’t end up costing the German taxpayers. That’s now almost unavoidable, given the inevitable Greek default. But they should not and will not commit to an open-ended fiscal union, i.e. to “taxation without representation.”

Scott as usual it is right on the nail…further comments are not needed.

But it is not really about whether Alabama…eh Germany… is rich enough to bail out the rest of Europe. The question is why some (all?) euro zone are in trouble. David Glasner has the answer:

“…the main cause of the debt crisis is that incomes are not growing fast enough to generate enough free cash flow to pay off the fixed nominal obligations incurred by the insolvent, nearly insolvent, or potentially insolvent Eurozone countries. Even worse, stagnating incomes impose added borrowing requirements on governments to cover expanding fiscal deficits. When a private borrower, having borrowed in expectation of increased future income, becomes insolvent, regaining solvency just by reducing expenditures is rarely possible. So if the borrower’s income doesn’t increase, the options are usually default and bankruptcy or a negotiated write down of the borrower’s indebtedness to creditors. A community or a country is even less likely than an individual to regain solvency through austerity, because the reduced spending of one person diminishes the incomes earned by others (the paradox of thrift), meaning that austerity may impair the income-earning, and, hence, the debt-repaying, capacity of the community as a whole.”

See also my comment on Ambrose Evans-Pritchard.


David Friedman on the price of money

I always considered David Friedman to be very special. I have read all his books and I seldom find myself disagreeing with him (we even have a odd interest in Iceland in common). However, I have a slightly controversial interpretation of David Friedman’s thinking – I think his views really is a reflection of what Milton Friedman really would have liked to say if he had been truly free to express his views. Milton Friedman was the one who with his writings both turned me into a monetarist and a libertarian, but David Friedman’s views in many ways are probably closer to what I think about most things. David Friedman as his father of course also is a fantastic writer and thinker.

David’s thinking in my view is the best illustration of what I in my book on his father called the pragmatic revolutionary. His views might on the surface not be all that radical, but once you understand the logic of his thinking you yourself become a radical. David is the best example of this and I hope I am as well.

David, however, has been carefully not writing or speaking too much about monetary issues – his dad’s speciality. However, his latest post on his blog is exactly about that.

David comments on a very import topic – the general misunderstanding that interest rates is the price of money. This is a key monetarist insight that Market Monetarists often also would put forward. Unfortunately David’s comments in Tim Congdon’s new book “Money in a Free Society”. David seems to think that Tim does not understand that money is the price of money. Contrary to this I think that Tim is very much aware that it is a fallacy to say to low interest rates is the same as easy money. I think the misunderstanding is due to Tim’s discussion of the institutional difference between UK and US monetary policies in the 1980s, but I don’t want to be the judge on that. Therefore, I will just concentrate on David’s argument, while I don’t think Tim should be held accountable for a fallacy that he obviously don’t believe in.

Here is David:

It is said that “interest rate” is “the price of money.”

“This is a very common error, and one that is not only wrong but dangerously wrong…If the price of an apple is fifty cents, that means that if I give a seller fifty cents he will give me an apple in exchange. If the interest rate is five percent and that is the price of money, I ought to be able to buy money for five cents on the dollar. I doubt … anyone else, will be willing to sell it to me at that price…The price of money is what you have to give up to get it—the inverse of the price level. If the price of an apple is fifty cents, the price of a dollar is two apples. The interest rate is the rent on money, measured in money. A change in the price of money affects both the money you are renting and the money you are paying as rent, leaving the ratio of the two unchanged…Suppose that at midnight tonight every dollar bill in the world twins, along with a similar change in the accounting entries for bank deposits, other forms of money, and all obligations denominated in money. By morning, there is twice as much money as before—and nothing else has changed…I would ask Congdon (it should be Mr. X!) whether, under those circumstances, he would expect the interest rate to drop. If his answer is yes, my next question is whether he would expect a much more extreme drop if we relabeled pennies as dollars and dollars as hundred dollar bills, thus increasing the money supply, measured in “dollars,” a hundredfold…The reason the description of the interest rate as the price of money is not only wrong but dangerously wrong is that it implies a simple relation between money and the interest rate—in the extreme (but not uncommon) version, the belief that interest rates are set by central banks, with high interest rates the result of a tight monetary policy…A central bank can create money and lend it out, increasing the supply of loans (which reduces the interest rate) and increasing the money supply. That is the one element of truth to the relationship. But what is affecting the interest rate is not the amount of money but the amount of loans; the government could get the same effect by collecting more in taxes than it spends and lending out the difference…The interest rate is a market price—the price paid for the use of capital—and the central bank controls it only in the same sense in which the government can control the price of wheat by choosing to buy or sell some of it. The central bank does not have an unlimited amount of capital from money creation to lend and so has only a limited ability to shift interest rates from what they would otherwise be. Furthermore, a continued expansion of the money supply creates the expectation of future price rises, which pushes the nominal interest rate up, not down.”

I wish more people would understand this, but most of all I would hope that David would write much more about monetary theory.

For those interested I have a discussion of the price for money and interest rates in my paper on Market Monetarism.


Update: I was a bit too fast – I did not read David’s none-economic books like Harald and Salamander.

Ambrose Evans-Pritchard comments on Market Monetarism

The excellent British commentator Ambrose Evans-Pritchard at the Daily Telegraph has a comment on the Euro crisis. I am happy to say that Ambrose comments positively on Market Monetarism. Here is a part of Ambrose’s comments:

“A pioneering school of “market monetarists” – perhaps the most creative in the current policy fog – says the Fed should reflate the world through a different mechanism, preferably with the Bank of Japan and a coalition of the willing.

Their strategy is to target nominal GDP (NGDP) growth in the United States and other aligned powers, restoring it to pre-crisis trend levels. The idea comes from Irving Fisher’s “compensated dollar plan” in the 1930s.

The school is not Keynesian. They are inspired by interwar economists Ralph Hawtrey and Sweden’s Gustav Cassel, as well as monetarist guru Milton Friedman. “Anybody who has studied the Great Depression should find recent European events surreal. Day-by-day history repeats itself. It is tragic,” said Lars Christensen from Danske Bank, author of a book on Friedman.

“It is possible that a dramatic shift toward monetary stimulus could rescue the euro,” said Scott Sumner, a professor at Bentley University and the group’s eminence grise. Instead, EU authorities are repeating the errors of the Slump by obsessing over inflation when (forward-looking) deflation is already the greater threat.

“I used to think people were stupid back in the 1930s. Remember Hawtrey’s famous “Crying fire, fire, in Noah’s flood”? I used to wonder how people could have failed to see the real problem. I thought that progress in macroeconomic analysis made similar policy errors unlikely today. I couldn’t have been more wrong. We’re just as stupid,” he said.”

So Market Monetarism is now being noticed in the US and in the UK – I wonder when continental Europe will wake up.


Update: Scott Sumner also comments on Ambrose here – and in he has a related post to the euro crisis here.

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