Joe SalernoEconomics Dept.Pace UniversityNew York City
I am writing to you because I regard you as the man of the hour, at least for the next 18 months. More than any other follower of Mises, you are the person who has devoted the greatest amount of thought to monetary theory. You also have the academic credentials that are necessary to get a hearing.
We have arrived at what I would call the economic point of no return. We have waited for this moment for at least 35 years. The crisis is upon us. For the first time, the mainstream academic world perceives that the economic world can really face a crisis of monumental proportions. This gives us an opportunity to get a hearing. I suppose I should say, this gives you an opportunity to get a hearing.
As far as I’m concerned, there were only three economists of note in the 20th century: Mises, Keynes, and Irving Fisher. All the other economists are spear-carriers in one of these three camps. Keynes was a fake. If you read his General Theory, you find that it is convoluted, incoherent, and horribly written. This is in contrast to virtually everything else he ever wrote. This indicates that he could not put the pieces together. The pieces did not fit; there was no coherent economic theory guiding the book.
Fisher was altogether different. He dominates current free-market theory because Milton Friedman was a follower of Fisher in every sense. Friedman made his reputation with his Monetary History of the United States, which was basically Fisher with footnotes. Anna Schwartz provided the footnotes.
I am sending you a URL to an article that states Fisher’s position about as well as anything I have ever seen in short, readable form. It then connects Fisher’s position with the events of the last 6 months. It says that the present expansion of the monetary base has not led to increasing prices. It says that Fisher predicted this, that the debt deflation in the capital markets would overcome any expansion of the monetary base. This is the old velocity argument.
Statistically speaking, so far, the argument has been supported by the facts. The monetary base has doubled since last September, but prices have tended to stay flat. In recent months, the consumer price index has actually declined, if you use the standard CPI figure. I prefer the Median CPI, but in the last month it has gone flat.
The argument hinges on one fact: banks will not lend. Borrowers do not wish to borrow, and bankers do not wish to lend. Therefore, the increase of the monetary base will have no effect in raising prices. What I do not understand about this argument is this: the United States Treasury will borrow anything it can get from anybody who is willing to invest at today’s low rates. The Treasury is going to mail out a check as soon as it gets the newly created money from the Federal Reserve. I see no indication at all that banks will not lend to the Treasury Department. Furthermore, if banks are paying the positive rate of interest, they must lend to some institution that will enable them to pay a rate of interest to the depositors. For as long as banks are accepting deposits, and as long as banks pay rate of interest to the depositors, I see no way that the banks will not lend. Yet nobody in the mainstream media makes this observation. The observation seems obvious to me, but nobody — I mean absolutely nobody else — is making this argument. Am I nuts?
The old deflationist argument presented by John Exter 35 years ago was basically Fisher’s argument. He believed that gold’s price would rise in this scenario, because gold is the ultimate form of money, meaning the ultimate form of liquidity. But his argument was essentially that of Fisher. He was given a hearing 35 years ago in the hard-money camp, but he has been quoted rarely since then.
We have not had massive inflation of the monetary base, and we have not had mass inflation in prices. So, we have not had a scenario in which Fisher’s theory would be tested against Mises’ theory. We now have the conditions that provide the arena for the test of the two theories.
This is why you are the man of the hour. You do not believe in the velocity theory. Neither do I. My explanation for why M1 has not forced up prices is that banks have been depositing funds as excess reserves with the Federal Reserve. The Fed has been paying interest on these excess reserves. Now, however, the Fed says it has targeted the federal funds rate at 0%. If this is the case, and if the Fed achieves its goal, then banks will no longer place extra money on deposit at the Federal Reserve. The banks will have to seek investments that pay something higher than what the banks are paying to depositors. The most obvious target would be T-bonds. I think the banks are already doing this. I think this is why Treasury bond rates have fallen. I told my subscribers a year ago November to put 20% of their money in long-term treasuries. That investment is up over 35%.
You have given more thought to the question of monetary theory and philosophy than anyone within the camp of the Austrian school. This is why I think you have got to go in to print, either on the Mises site or the Rockwell site, to deal with the great debate between Fisher and Mises. The great debate, which began almost a century ago, is now facing its first major test. It was not a tested in the Great Depression, because banks were allowed to go bankrupt. There was a shrinking of the money supply. Today, the monetary base and the monetary aggregates are growing rapidly. At the same time, the statistics on the money multiplier indicate that there is an offset to M1.
We need two things. First, we need an explanation for why the money multiplier has fallen. I think the most likely answer is the increase in excess reserves held at the Federal Reserve. The second thing we need a refutation of velocity.
If Mises was correct, the expansion of the monetary base will be matched by an expansion of the monetary aggregates, and this will lead to extreme price inflation on a scale comparable to the increase of the monetary base. The monetary base has doubled since last September. On the other hand, if Fisher was correct, and if velocity is crucial, then we will not see an increase of prices comparable to the increase of the monetary base. We might even see slightly decreasing prices. If we see decreasing prices, then it will be very difficult for Austrian economics to recover. It will mean that Mises was wrong on money. It will also undermine Mises’ methodology, since he always argued that the facts cannot refute logical theory. Hardly anyone believes him. So, on two fronts, Austrian economics will be under assault.
You, more than anyone else, are in charge of the assault rifles. I hope you will load up several magazines with ammo, get out your AK-47, and start shooting.
January 27, 2009
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