Hard Money Is Hard

Some around these parts already know that I judge the market monetarist approach of NGDP level-targeting to be the ‘least-bad’ system of a fiat-money-based monetary regime.  I am persuaded of this for purely ‘technical’ reasons.  That is – by logical arguments related to reasonable theoretical models of the dynamics of our economic and financial systems and considering questions of what strategies might be ‘least ineffective’ / ‘least-inefficient’ in reducing volatility and instability while the economy continues to evolve to wherever it is going.

Someday soon, when time permits, I’ll try to lay out my version of what I refer to as this ‘technical case’.  But we don’t live in a world of pure technocratic consideration where optimal policies overlap perfectly with the politically plausible, and so there are other reasons to favor this particular reform.

For starters, the ‘improvement to change’ ratio is probably the highest for this reform.  Because it is neither radical nor revolutionary, and since it keeps some of the best, while eliminating some of the worse of the current system, it is likely to be perceived as a benign tweak (or even kludge) to the contemporary regime.  It has some real (though currently small) likelihood, in other words, of being implemented by the current players without experiencing the turmoil of the equivalent of complete social and economic upheaval.

But there are also political considerations, and I would submit for your consideration a recent post by Scott Sumner, who at The Money Illusion has been the most vocal, persistent, and uncompromising advocate of NGDP level-targeting in the econoblogosphere for the past 4.5 years.

I don’t agree with Sumner on everything, particularly his absolutist-EMH thoughts on bubbles (i.e. – they don’t exist / there’s no good useful definition of when they do) and I’d recommend Arnold Kling’s and Interfluidity’s takes on his theories to you.  But in general I think he’s right about NGDP level-targeting, and it’s a subject and argument with which you should acquaint yourself.

Whatever, you think about the wisdom, prudence, or benefits of hard money, I think he makes a convincing, if obvious, case that hard-money policies are political losers in democracies, since the left can always argue that the occasional down-turn is a result of those policies, and that if they are elected, the loose-money, deficit-spending policies they will enact will stimulate the economy, relieve debts, and hand out government goodies to all the distressed.  It’s the familiar structural disadvantage of any uncomfortable discipline against temptation whatsoever associated with the short-time horizons of democratic politics.

So, until democracy is formally discarded, conservatives would be wise to institute policies that limit political discretion and build in an allowance for a little looseness in warranted circumstances, compensating with subsequent tightness when the storms pass.


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19 Responses to Hard Money Is Hard

  1. Vladimir says:

    One point where Sumner seems to lack a clear understanding is that the historical failure mode of hard money in the democratic age has been the practice of fractional-reserve banking (and maturity-mismatched finance in general). When the inevitable FRB-induced bank runs and financial panics cause widespread economic hardship, there’s always the popular clamor for the government to ease the pain and prevent similar things from happening in the future. In the democratic age, this has unsurprisingly led to a gradual government takeover of money and the drift from hard money to an out-and-out monetary Gosplan. (One of Moldbug’s best insights, and at the same time one of the largest blind spots of many libertarians, is that a combination of a free-marked hard money system and FRB is indeed a recipe for disaster, both economic and political.)

    That said, of course, nobody knows whether it is possible, even in theory, to have a stable hard-money system in which FRB is somehow prevented from wreaking havoc. Certainly no such thing is politically feasible anywhere in the world in the foreseeable future. So here we get to this idea, very Friedmanite in spirit, that since the Gosplan is here to stay, we should try to sell the planners in charge on the idea that they should follow some kind of predictable and hands-off management style — for example NGDP-targeting. This, I understand, is the minimal case for NGDP targeting that you propose towards the end of your post. Sumner (and I’m not sure if you too?) would make a stronger claim that it is in fact the best of all possible, not just politically feasible arrangements.

    I see at least two major problems with the whole idea, which in my opinion decisively bury the strong claim, and also leave me with a lot of skepticism towards the weak one:

    1. Like all socialist planning, this sort also runs into the calculation problem. What is this “NGDP” thing anyway? In his excellent (and unsurprisingly buried and forgotten) book “On the Accuracy of Economic Observations,” Oskar Morgenstern (of the von Neumann-Morgenstern theorem fame) decisively demolished the idea that any such thing could ever be measured with any reasonable accuracy. And here we’d like to do central planning with an approach that requires measuring it to a 0.1% precision! (If anything, just from everyday observation, it’s clear that the size of the unmeasurable grey economy is two orders of magnitude larger than this margin, even in the most orderly and tightly governed states in the world.)

    Therefore, what reason do we have to think that NGDP targeting wouldn’t soon degenerate into the usual sorts of bureaucratic and pseudo-scientific bungling and doctoring of (anyhow bogus) figures for both ideological and venal interests?

    2. Even more important, an inflationary regime always leads to a corrosive and creeping socialism. If it’s not rational to save money because it will get eaten away by inflation, then you have only three options: don’t earn it in the first place, squander it, or engage in speculation and hope to earn yields above inflation. The first two options mean that you become a client of the welfare state. The third option superficially looks like a heroic-capitalist one, but in reality, ordinary people want, first and foremost, safety and stability for their savings — they don’t want to live their whole lives under the Damocles’ sword of getting wiped out by market crashes and changing interest rates, and despite their braggadocio, they understand at some level that in the game of speculation they are the suckers at the poker table.

    Therefore, naturally, they demand government intervention to ensure the stability of their assets. Further, once it’s considered the right and duty of every citizen to be a speculator, it’s a natural step to demand cheap and loose credit to fuel this speculation, and not to mention all the rent-seeking special interests that will attach themselves like lampreys to these streams of fiat cash. The hideous spectacle of modern-day real-estate markets is only the most extreme and obvious example of this trend.

    The longer-term consequences of all this on future time orientation and cultural attitudes towards productive and civilization-building efforts are too frightful to contemplate. Keynes was truly right when he wrote that inflation is a process that “engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” Thankfully, for the last few generations we’ve been saved by technological progress that’s been feeding on a few remaining oases of non-perverted incentives. But whatever happens in the future, I see now reason to expect that the inflationary regime’s fundamental evils would be ameliorated in any way by a shift to NGDP-targeting.

    • Genius Hans says:

      a combination of a free-market hard money system and FRB is indeed a recipe for disaster, both economic and political

      I have not seen evidence for this claim. When and where has the combination spearheaded a political disaster? Today’s riffraff thinks of the state as a surrogate parent and would expect to compensated after a bank run, but back when there was a free market in money the passions of the masses seem to have been stirred primarily by memes of liberation, democracy and economic equality.

      FRB is not a great formula for class warfare. Bankers, unlike the Ancien Régime, bourgeosie or white male oppressors are a tiny, rigidly defined group that would never have a great deal of power to be grabbed. Furthermore the excuse for central banking is that the economy needs to be managed to control inflation and the business cycle, and this is upheld by academic obfuscation that flies over the canaille’s head. Other étatiste interventions are justified by a straightforward moral appeal: equality is good, discrimination is bad, etc. It is these ideological crusades that exploit the herd’s deepest passions, and can be manipulated to overthrow any powerful authority or tradition.

      It therefore seems to me that libertarians have no such blind spot: FRB and bank runs are not one of the major engines of étatisme. A solution to the triumph of progressivism in big ideological issues would also probably suffice to make FRB + hard money stable.

      In any case, the problems caused by maturity mismatching could be minimised through libertarian paternalism. Popular institutions that practise FRB could be compelled to wear a hazard warning, people could be prompted about the risks when they visit an ATM, there could be a maturity-match inspectorate, and so on as Thaler & Sunstein have described.

  2. Vladimir says:

    I don’t agree with Sumner on everything, particularly his absolutist-EMH thoughts on bubbles (i.e. – they don’t exist / there’s no good useful definition of when they do) and I’d recommend Arnold Kling’s and Interfluidity’s takes on his theories to you.

    Do you have some particular links to Kling or Interfluidity to recommend?

    I find this sort of “absolutist” attitude towards (weak) EMH and bubbles to be eminently sensible, and in fact a refreshing dose of common sense on a topic on which almost everything people say and write is rubbish. Bubbles can be a useful concept for analyzing past events, but unless you have some sort of very extraordinary insider knowledge, there is never any good reason to believe that any current asset prices are bubbles. I.e., anyone who uses the word “bubble” and present tense in the same sentence is necessarily talking nonsense — as evidenced by the fact that if he were right, he could get rich if he just put his money where his mouth is.

    Sumner’s problem, in a sense, is that he doesn’t take his EMH extremism far enough. One of the most striking and useful implications of EMH is that his own field of macroeconomics cannot possibly be a valid science — for the simple reason that any macroeconomic theory that is at the same time novel, non-trivial, and true would enable one to second-guess the markets, and any disagreement on macroeconomic predictions is ipso facto an arbitrage opportunity.

    • Nick Land says:

      These two comments are among the most excellent I’ve ever seen, anywhere.
      It’s easy to underestimate just how analytically powerful the EMH is. Your remarks serve as a corrective.
      @ Handle — How would you respond to a critic who criticized these ideas, on the basis that they’re simply trying to find a way to help the Cathedral sustain itself (against the hurricane gusts of its own incompetence)? If we’re resigning ourselves to the Cathedral’s (current) political impregnability, shouldn’t we at least console ourselves with its economic self-ruination?

      • Handle says:

        This is more along the lines of the kind of discussion I was hoping to inspire. My attempt at deferment of technical considerations was a failure, however, rewarded immensely by Vladimir’s characteristically formidable responses. Vlad, if you’re reading, I promise I’ll try and respond to your points as soon as time permits which … will probably not be this week. Business, family, you know how it is.

        Ok, now to Nick’s point.

        I would say that I’m not of the ‘let the house of cards collapse on its own weight’ party.

        First, on a purely personal level, my family and I happen to live in that house of cards. Also, there are some big and little bad wolfs out there who try to blow it down and I am employed in a capacity that is trying to prevent that; so it is unlikely that I would be indifferent concerning matters of structural integrity.

        Second, as a matter of judgment, I think the USG-collapse / apocalypse / ruin meme is seriously overwrought. As one anecdote on one subject, I’ve been trying to push back against the imminent-hyperinflationists for years, and though it’s crass to act the umpire in one’s own fight, I think I’ve won but have seen the other side twist itself into contortions of ex-post-facto retro-self-hermeneutics trying to derive ‘correctness, from a certain perspective’ from their failed assertions and predictions. At a certain point, you realize you’re dealing with a psychological seduction-by-calamity-dream phenomenon, and not a consideration of arugment, logic, and evidence.

        There’s concern, caution, a sober analysis which leads to justified worry, etc. And then there’s a point where it spills over into paranoia then hysteria and delusion. Maybe I should be building my bunker with food stores and ammunition and gold and top shelf whiskeys and the great-book-of-societal-reconstruction, but I’m not and think people that are doing so are being ridiculous.

        And I respect Jim a lot, but I just disagree with this both as prediction as strategy, “I don’t see that as a problem. I see chaos coming. Power will fall into the street, hot, radioactive, dangerous, and desired, to be picked up first by one group, then another, each new pair of hands slippery with the blood of innocents, after the fashion of the Arab spring….”

        I don’t think that’s going to happen, and if it became probable, I don’t think one should want it to happen and that one should prevent it if preventable, no matter how much one despises the Cathedral or the current state of affairs. Chaos is bad.

        But mostly, I have a different strategy of conversion in mind which I think is more plausible and more likely. I’ll more more about it soon … I hope.

        • Alrenous says:

          “I don’t think one should want it to happen and that one should prevent it if preventable, no matter how much one despises the Cathedral or the current state of affairs. Chaos is bad.”

          This bears repeating and emphasizing, I think.

          There’s a counter-point to be made in that if chaos is not preventable, generally you want it sooner rather than later, as the reckoning gets worse the longer you kick the can, and it seems quite likely that the looming chaos is not preventable.

          But then there’s the counter-counter point of who hired me to keep chaos down? That’s not my responsibility. Until someone renumerates me in exchange for a relevant oath, I’m not willing to sacrifice so much as a hang-nail to oppose apocalypse. In this case, Rand was right.

          • Handle says:

            “But then there’s the counter-counter point of who hired me to keep chaos down? That’s not my responsibility. Until someone renumerates me in exchange for a relevant oath, I’m not willing to sacrifice so much as a hang-nail to oppose apocalypse.”

            Someone did hire me, had me swear an oath, made it my duty, but I would tend that way regardless.

    • Candide III says:

      Vladimir, now that Handle has got a blog, it’s your turn!

      Part of the problem with EMH is that its name is so misleading. The “efficient” in EMH is a technical term, but many people seem to conflate it with the ordinary meaning of “efficient” and/or with other technical meanings ascribed to the word in other contexts. They then proceed to adduce various examples and arguments based on this conflation — for instance, that market bubbles lead to malinvestment, which is inefficient, ergo the market is not really efficient — while the fact of the conflation often flies under the radar.

      The other thing is that a sufficiently determined government can win against the market by changing the rules with one hand while participating in the market with another. In an extreme case, the government abolishes private property and all market players lose.

    • vm says:

      Pace Fisher and Friedman (ironic, considering their bogey-man status in Moldbug’s narrative), I don’t see much to recommend narrow banking. I could be convinced though. All it would take is for someone to start a narrow bank and make it work. Proof, after all, is in the pudding.

      • Handle says:

        A narrow-banking advocate would say we can’t do the experiment because of the ‘race to the bottom’ effect of unregulated markets. If a company finds an environmentally cleaner, but significantly more expensive, method to produce a product (the demand for which is unrelated to the details of its manufacture), then it cannot hope to thrive in a market in which its competitors produce cheaper, more polluting, but otherwise identical substitutes because the consumers are insensitive to the distinction.

        So, except for perhaps a niche market, a narrow bank could not hope to be genuinely competitive with modern FRL TBTF banks. This barrier to entry is an insurmountable obstacle to pudding-diving for proof.

        • vm says:

          No one is forcing narrow banking advocates to draw their examples from or restrict their analysis to the present. They have the whole of human history to search for a precedent. If narrow banking really is so much more advantageous than fractional reserve banking, then there ought to be plenty of instances of it that they can point to.

          Notice as well that the argument advanced by narrow banking advocates is basically that we have FRB and financial crises; therefore, FRB causes financial crises, and thus the solution to financial crises is to outlaw FRB. I don’t find this persuasive (though mileages obviously differ). It also fails to account for whatever the socially useful function of FRB might be. Given the historical dominance of FRB over the academic suggestion of narrow banking, that’s something that needs to be explained. What is the trade-off we face here? If the claim is that there is no trade-off, is this even remotely believable?

    • vm says:

      Sumner’s problem, in a sense, is that he doesn’t take his EMH extremism far enough. One of the most striking and useful implications of EMH is that his own field of macroeconomics cannot possibly be a valid science — for the simple reason that any macroeconomic theory that is at the same time novel, non-trivial, and true would enable one to second-guess the markets, and any disagreement on macroeconomic predictions is ipso facto an arbitrage opportunity.

      Sumner is an economic historian and not a macroeconomist, but I think your argument here contains a contradiction. The EMH is an economic theory (the implication of which is that one cannot second-guess the market in terms of predicting asset prices), so it can’t be brought into play to discredit all economic theory.

      Moreover, there is a large body of modern macro that takes as its starting point the assumption that the market cannot be second-guessed and that the outcome obtained is always the optimal solution. From this perspective there is little to no role for central banks or governments.

    • Handle says:

      “Bubbles can be a useful concept for analyzing past events”

      This is an important caveat. Sumner doesn’t even admit that, which I’ll grant is a consistent position, but one I’m not persuaded by. He rejects the whole concept of bubbles altogether. When he looks at the graph of house prices or Mortgage-Equity-Withdrawl reversing by a net 15% of Personal Income, he merely repeats, “NGDP got off track”.

      I think if you try to explain how we would go about that analysis you will see why I think your statement is problematic. If we can go back and say anything more than “the price went way up, and then it collapsed back down, so it was a bubble”, then what conditions are we describing and what explanations are we making?

      Personally, I favor an approach (I think like Steve Keen’s though I haven’t read him in a while) of focusing on rapid changes in leverage and underwriting standards for extension of credit. This was definitely true in the case of the American housing market, and all the other personal consumption expenditure markets which were goosed, inter alia by large parts of the country being able to boost their purchasing power by 10% or so by using their houses as ATM’s.

    • jamesd127 says:

      In November 2005 I said “Now is the time to panic”. It was immediately obvious to me that a bunch of other people came to the same conclusion at the same time, yet the bubble was artificially extended by regulation, political pressure, and political correctness all the way to 2007-2008.

      So I could see a bubble at the time.

      Suppose the majority is insane, and the minority is sane, a very common situation, known as the madness of crowds. Is the minority incapable of knowing that it is sane?

      In this situation the majority think they are sane, because they are insane, and the minority think they are sane, because they actually are sane. One can tell the difference, even if the majority refuse to tell the difference.

  3. asdf says:

    Interfluidity is fantastic, probably the best around today.

    “as evidenced by the fact that if he were right, he could get rich if he just put his money where his mouth is.”

    Except there are people that put their money where their mouth is and do get rich of it. Hell, even I turned my little pile of money into a slightly bigger little pile of money by predicting the housing bubble was a bubble and then trading on it near the height. I have absolutely no clue what you are trying to say here. There were obvious reasons, at the time, to consider it a bubble and everyone who called it a bubble were right.


    I agree with the Doom and Gloom. It’s pornography. The likely scenario is to limp along in non-dramatic stagnation/decay. And the likely result of collapse is chaos and something worse, which is what almost always happens in collapses.

  4. Jefferson says:

    Firstly, to echo what mr. Land said earlier, Vlad’s comments are amongst the best I’ve ever read. Secondly, while general collapse is unlikely (Rome didn’t collapse from stagnation, it collapsed from stagnation and external conquerors), we’re seeing a series of localized collapses. Obviously there’s Detroit, but also there’s the collapse (or at least squeeze) of the middle and lower classes due to automation and outsourcing, the collapse of the family in many sectors, and the collapse of our education system. There seems to be a rift in the reactosphere between those affected personally by these changes as well as those with an abundance of empathy and those who are unaffected.

  5. Kgaard says:

    A reasonable solution here is simply to raise capital requirements on banks. The problem isn’t fractional reserve banking itself. The problem is that bank capital levels (the “fraction” in fractional reserve) have gotten too small. By contrast, in emerging markets — where there is no Fed to bail everybody out when the bankers make bad choices — banks maintain much higher capital ratios. In places like Kazakhstan, Serbia and Turkey, banks routinely maintain 16% capital ratios. In Sri Lanka and Pakistan it’s like 11-13%. Moreover, these banks are very intense about their collateral requirements. If you default, they will reclaim their stuff and re-sell it, recouping virtually all the value of the loan. If you look at NPL ratios of Sri Lankan banks, they basically run about ZERO because recoveries offset provisions.

    The conspiracy here is the one outlined by Griffin in The Creature from Jekyll Island. The existence of the Fed allows these US banks to run at too-low capital ratios. THAT is what needs to be combatted. If you got rid of fractional banking altogether … well … I don’t think that would be good. Unbanked countries generally look pretty bad.

    BTW … European banks are even worse than US banks — their TANGIBLE capital ratios are low single digits. It’s pretty pathetic. The system survives because the ECB guaranteed basically everything.

    • Handle says:

      Here’s a kind of analogy:

      Americans love predictable budgeting. In most other countries, people are more comfortable with pay-as-you-go. They pay for minutes or text messages and so on.

      But Americans tend to prefer subscription packages. Pay $X a month, and get a maximum of Y amount of usage of some service.

      This is especially true in organizations, and practically the ultimate administrative law within the executive departments of USG.

      But what if your organization wants to buy an alternative service, say ‘cloud storage’, that the marketplace offers on a pay-for-use basis instead of a subscription basis.

      If you run the data-service provision arm of your department, your boss asks you, “what’s the budget for cloud?”

      And you answer, “Who knows. It depends entirely on how much our employees use the service, and it’s highly unpredictable. Could be half a million, could be two million. On average it’s a million, but half the time it’ll be more, and without more money we’d have to stop work. Even budgeted at two million, there’s no guarantee we won’t have an extremely busy year and run out of money.”

      And of course, you can’t roll-over unspent money.

      So, yes, this system is stupid. Don’t argue the system, accept it as given in your set of assumptions. Solve the problem as stated – what budget level do you pick?

      The one with a 10% chance of busting? 5%? 0.1%? Every dollar value has some positive probability of being insufficient.

      This same logic applies to reserve requirements, which is why there was so much debate about it at each step of the Basel-III process.

      And there’s a trade off. Higher reserve requirements are safer (though never truly safe), but many mildly profitable businesses on the margin will lose access to credit, which decreases output and productive-factor-accumulation and thus growth rates.

      Speaking of the American preference for regular, predictable budgeting, the huge popular demand for this kind of financial certainty amongst consumers is also why the process whereby demand-deposits are maturity transformed into 30-year fixed-rate mortgages guaranteed by the government isn’t going away. People demand it – a democratic government supplies it.

      • Kgaard says:

        Yes, very astute arguments. If you raise the cost of capital you raise the hurdle to new debt-financed growth. But if we look at your argument from another perspective, we can see that the NEED to make money super cheap (via low rates, and super-low capital requirements) is actually a response to bad fiscal policies. In other words, if taxes/regulations are too onerous, growth won’t happen … UNLESS you make money really cheap. This is the bind the Europeans got themselves in. So, the proper mix is to have low tax rates and higher bank capital requirements (at LEAST 10% for god’s sake).

        Here’s another way to think about it: The reason the Fed conspiracy was hatched in the first place back in 1910-13 is that banks were seeing their returns decline — precisely because they had to keep high capital ratios and were getting beaten out by equity financing. So they stacked the deck in their favor by creating the Fed to socialize losses when the system went belly-up (thereby allowing the banks to run at lower capital ratios). But why not go back to a more pre-Fed style situation where financing is done more via equity than debt? Couldn’t that work even easier today with the internet and all? Also … it seems to me that Sharia banking is based on this concept and it works pretty well. (I used to work on some Sharia banks in Turkey in my existence as an equity analyst.)

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