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Europe and Deflation Paranoia – Article by Frank Hollenbeck

Europe and Deflation Paranoia – Article by Frank Hollenbeck

The New Renaissance Hat
Frank Hollenbeck
April 30, 2014

There is a current incessant flow of articles warning us of the certain economic calamity if deflation is allowed to show its nose for even the briefest period of time. This ogre of deflation, we are told, must be defeated with the printing presses at all costs. Of course, the real objective of this fear mongering is to enable continued national-government theft through debasement. Every dollar printed is a government tax on cash balances.

There are two main sources of deflation. The first comes from a general increase in the amount of goods and services available. In this type of deflation, a reduction in costs, in a competitive environment, leads to lower prices. The high technology sector has thrived in this type of deflation for decades as technical progress (e.g., the effect of Moore’s Law) has powered innovations and computing power at ever-decreasing costs. The same was true for most industries during much of the nineteenth century, as the living standard increased considerably. Every man benefited from the increase in real wages resulting from lower prices.

The second source of deflation is from a reduction in the money supply that comes from an increase in the desire of the public or banking sectors to hold cash (i.e., hoarding).[1] An uncomplicated example will make this point clearer. Suppose we have 10 pencils and $10. Only at an equilibrium price of $1 will there be no excess output or excess money.

Suppose the production cost of a pencil is 80 cents. The rate of return is 25 percent. Now suppose people hoard $5 and stuff money in their mattress instead of saving it. The price of a pencil will be cut in half, falling from $1 to 50 cents, since we now have a money supply of $5 chasing 10 pencils. If input prices also fall to 40 cents per pencil then there is no problem since the rate of return is still 25 percent. In this example, a drop in output prices forced an adjustment in input prices.

The Keynesian fear is that input prices will not adjust fast enough to a drop in output prices so that the economy will fall into a deflation-depression spiral. The Keynesian-monetarist solution is to have the government print $5 to avoid this deflation.

Yet, this money creation is distortive and will cause a misallocation of resources since the new money will not be spent in the same areas or proportions as the money that is now being “hoarded” (as defined by Keynesians). Furthermore, even if the government could find the right areas or proportions, it would still lead to misallocations, since the hoarding reflects a desire to realign relative prices closer to what society really wants to be produced. The printing of money may actually increase the desire to hold cash, as we see today. Holding cash may be the preferred choice over consumption or investment (savings) when relative and absolute prices have been distorted by the printing press.

Of course, no one is really asking the critical questions. Why does holding more cash change the money supply, and why did the public and banks decide to increase their cash holdings in the first place?[2] Without fractional reserve banking, neither the public nor the banks could significantly change the money supply by holding more cash, nor could banks extend credit faster than slow-moving savings. The boom and ensuing malinvestments would be a thing of the past and, thus, so would the desire to hold more cash during the bust phase of the business cycle. If central banks are really concerned about this type of deflation, they should be addressing the cause — fractional reserve banking — and not the result. Telling a drunk that he can avoid the hangover by drinking even more whiskey is simply making the situation worse.[3] The real solution is to have him stop drinking.

According to the European Central Bank’s Mario Draghi,

The second drawback of low inflation … is that it makes the adjustment of imbalances much more difficult. It is one thing to have to adjust relative prices with an inflation rate which is around 2%, another thing is to adjust relative prices with an inflation rate which is around 0.5%. That means that the change in certain prices, in order to readjust, will have to become negative. And you know that prices and wages have a certain nominal rigidity which makes these adjustments more complex.

Draghi is confusing the first source of deflation with the second. The recent low inflation in the Euro zone can be attributed primarily to a strengthening of the Euro, and a drop in food and energy prices.

Economists at the Bundesbank must be quietly seething. They are obviously not blind to the ECB’s excuses to indirectly monetize the southern bloc’s debt. Draghi’s “whatever it takes” comment gave southern bloc countries extra time. Yet, little has been done to reign in the size of bloated public sectors. Debt-to-GDP ratios continue to rise and higher taxes in southern bloc countries have caused an even greater contraction of the private sector. Many banks in southern Europe are technically bankrupt. Non-performing loans in Italy have gone from about 5.8 percent in 2007 to over 15 percent today. And, the situation is getting worse.

Greece recently placed a five-year bond at under 5 percent which was eight times oversubscribed. This highlights the degree to which the financial sector in Europe is now dependent on the “Draghi put.” As elsewhere in the world, interest rates in Europe are totally distorted and no longer serve the critical function of allocating resources according to society’s time preference of consumption, or even reflect any real risk of default.

The ECB will likely impose negative rates shortly but will discover, as the Fed and others did before it, that you can bring a horse to water but cannot make him drink. QE will then be on the table, but unlike the Fed, the ECB is limited in the choice of assets it can purchase since direct purchase of Euro government bonds violates the German constitution. One day, Germany and the southern bloc countries, including France, will clash on what is the appropriate role of monetary policy.

Germany would be wise to plan, today, for a possible Euro exit.


[1] Keynesians view holding cash, and even holding savings in banks as “hoarding,” but properly understood, only the equivalent of stuffing money in a mattress is hoarding.

[2] Fractional-reserve lending is inflationary, thus contributing to inflationary booms. In turn, banks hold more cash when they fear a confidence crisis, which is also a result of the boom.

[3] Since inflationary fractional-reserve lending is a source of the problem, additional lending of the same sort is not the solution.

Frank Hollenbeck teaches finance and economics at the International University of Geneva. He has previously held positions as a Senior Economist at the State Department, Chief Economist at Caterpillar Overseas, and as an Associate Director of a Swiss private bank. See Frank Hollenbeck’s article archives.

This article was published on and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

On Moral Responsibility in General and in the Context of Voting – Article by G. Stolyarov II

On Moral Responsibility in General and in the Context of Voting – Article by G. Stolyarov II

The New Renaissance Hat
G. Stolyarov II
November 3, 2012

Here, I aim to briefly outline the general nature of moral responsibility as well as its implications for how a person ought to approach voting in an election.

Moral Responsibility in General

The source of all morality is the life of the human individual. As I explain in my video series, “Life as the Origin and Basis of Morality” (see Part 1 and Part 2), the life of the individual is the necessary precondition for any moral system, and therefore the preservation of that life is the foremost moral principle. The principle has to be universalizable to all individuals, or else one’s claim to the legitimacy of protection for one’s own life would be arbitrary and simply a matter of “might making right” (that is, if one can protect oneself against stronger individuals who do not recognize this legitimacy). If, however, one recognizes that the moral primacy of life is an abstract principle that can be applied to every person, then one can justly claim the moral high ground in defending one’s own right to life as an implication of this principle.

The existence of moral responsibility arises from two facts: (i) human beings can choose their actions, and (ii) various human actions can have varying degrees of beneficial or harmful consequences to human life. An action is moral if it benefits the life of any human being (including the actor) without harming any other human being. An action is immoral if it directly and unavoidably harms the life and infringes on the legitimate prerogatives of any human being – even if some other party might benefit from the action. Because each individual human being is an end in him- or herself, no action that “benefits” some people by harming others can be considered moral.  The deliberate and direct infliction of harm upon any person trumps any possible benefit that can be gained from an action. Furthermore, in reality (contrived hypothetical “train-track” scenarios notwithstanding), it is causally impossible for a harm to result in a benefit and for genuine benefit to be unachievable without harm.

Moral responsibility can be a source of both praise and criticism. A person should be praised if he is morally responsible for a beneficial action. A person should be criticized if he is morally responsible for an accumulation of sufficiently harmful actions. It is possible for a generally good person to be morally responsible for a harmful action. This alone does not make the person evil, and a person may compensate for a harmful action through restitution to its victims. Once appropriate restitution has been made, the harmful action should cease to adversely affect our judgment of the perpetrator. However, restitution to persons other than the victims would not suffice, because the benefit of one person cannot outweigh the harm done to another. If irreversible harm has been done, the moral wrong cannot be fully righted, and therefore the perpetrator must always bear some degree of moral responsibility. However, the adverse judgment of the perpetrator can be mitigated if the victim remains alive and decides that the perpetrator can confer a certain alternative benefit that would compensate for the harm without undoing it.

To clarify, this principle does not prohibit or denounce the use of force in order to defend oneself against harm or to punish a wrongdoer who has inflicted harm, as long as the punishment is proportional to the harm and has the effect of preventing future harm committed by such a wrongdoer. However, the retaliatory use of force is only appropriate if directed against genuine wrongdoers, exercised with extreme care for its proportionality, exercised lawfully, and performed without “collateral damage” to innocents. Infliction of harm upon an innocent person is never morally justified, for any goal.

A person is only morally responsible for actions directly within his or her control. A person does not bear any share of “collective guilt” for the actions of others whom somebody deems to be “similar” to that person in some respect. Neither does a person bear any “blood guilt” for the actions of ancestors or descendants. Sometimes a person’s actions may contribute to a larger harm – as when large numbers of people make poor decisions that result in a combined substantial damage to the lives of some innocents. In that case, each person whose actions directly contribute to the harm bears some degree of moral responsibility, in proportion to his or her contribution to the harm. However, in such cases, it is extremely difficult to isolate the contribution of any particular individual, and so the most practical remedy is not restitution, but rather the persuasion of individuals to desist from continuing to contribute to the harm.

Because moral responsibility relates to actual benefit and harm to human beings, there can be no moral responsibility for “victimless” actions, though one can bear moral responsibility for either benefiting or harming oneself. The moral responsibility for harming oneself can only be compensated for through reparations to oneself – i.e., through performance of actions that benefit oneself and undo the harm. Thus, actions that harm oneself alone cannot be undone by adhering to the dictates of others, and so no prohibition or external punishment can ever be appropriate for such actions. This is why a legitimate legal system would only prohibit and punish harm inflicted by an individual upon others and would allow an individual to harm himself without legal penalty. In this way, a class of immoral actions (harms to oneself) ought to be entirely legal. If an action does not damage the life of either oneself or others, then it can be neither illegal nor immoral.

While morality ultimately focuses on consequences, an individual’s intent in carrying out an action can have long-term effects on that individual’s moral standing. It is possible to have ill intent in carrying out an action but, through good fortune, to end up harming no one. In that case, no moral responsibility can exist because no one has been harmed. However, a person who continues to act upon ill intent is extremely likely to cause actual harm through repeated action. Therefore, acting with ill intent is like a game of Russian roulette as far as moral responsibility is concerned. One might escape moral responsibility any given time, but the probability of incurring it in the future is close to certain. Furthermore, acting with ill intent ultimately damages the individual’s capacity to choose morally, as it results in the reinforcement of habits of thought which oppose the preservation of human life and the cultivation of human civilization.  Likewise, good intent can assist an individual in committing moral actions by cultivating habits of thought that render moral choices easier. However, good intent must be reflected in benefits to human life before an action can be considered moral. Good intent cannot absolve a person of moral responsibility for a harmful act, though it should (if aided by an understanding of cause and effect) assist the person in avoiding similar harmful acts in the future.

 Moral Responsibility and Voting

In any scenario of voting, the individuals who participate are numerous, and the outcome results from an aggregation of individual votes. No given person can be said to specifically be responsible for the outcome of the election being one way or another, even if the outcome results from a difference of one vote (because anyone else’s one vote would have had the identical impact). Nonetheless, if the outcome of an election is the rise to office of politicians who perpetrate harmful actions, then the people who voted for those politicians share some of the moral responsibility in the harms – since, without the vote, those politicians would most likely not have come to power (unless they staged a coup). A clear case of this is the moral responsibility of the Germans in 1933 who gave Hitler’s Nazi Party the plurality of the vote. Were it not for this moral sanction, the harms committed by the Nazi Party would never have come to pass. Of course, the moral responsibility of the typical German voter who supported Hitler was slight compared to the moral responsibility of the actual Nazi leaders and their followers who actually partook in carnage and destruction. Nonetheless, by committing an action that clearly demonstrated support for the Nazi Party, even the otherwise peaceful Germans who voted for it helped to make its atrocities possible.

A person who does not vote for a winning candidate (either by voting for a losing candidate or by not voting at all) cannot have moral responsibility for what transpires when the winning candidate is elected, because he did not grant support to and sometimes explicitly opposed the winning candidate. He can therefore justifiably say, of what transpires afterward, that it did not transpire with his approval or assistance. In electoral situations, it is seldom the case that a single person can make all the difference (unless he is exceptionally good at persuasion of vast numbers of people), but a single person can choose not to be part of the problem. This is why a person should always vote his conscience (if he votes at all) and should never support a candidate who might commit incremental harm relative to the status quo, in that person’s view. However, a person could justifiably support a candidate who might bring about incremental benefit, even if that benefit is not as comprehensive as the voter might desire.

It is important to note that voting for a candidate who would commit incremental harm is not justified by the presence of a candidate whom one expects to commit even greater harm. Because harm can never bring benefit, it should follow that the infliction of lesser harms can never avert greater harms. The person who actively supports a move in the direction of harm (relative to the status quo) simply legitimizes the political system’s infliction of harm upon himself and others. By signaling to the political system that he will tolerate a certain degree of incremental worsening of his situation, he invites politicians to gradually ratchet up the degree of harm they cause, as long as they can claim (justifiably or not) that their opponents would bring about even greater harm.

In this case, what is the nature of the moral responsibility of the person who votes for a “lesser evil” in his mind? If the “lesser evil” loses, then there is clearly no moral responsibility if the person did not otherwise engage in harmful behavior to promote the “lesser evil” or to damage those who criticized the “lesser evil.” However, support for a losing “lesser evil” can lead to unfortunate habits of thought that would leave one vulnerable to the entreaties of politicians who intend to inflict harm. Just like ill intent in committing an action leaves one vulnerable to committing harm in the future, voting for a losing “lesser evil” leaves one vulnerable to voting for a winning “lesser evil” in the future. If one votes for an incrementally harmful candidate who wins, then one does share in the moral responsibility of those actions which a reasonable person could have anticipated on the basis of the candidate’s past record, rhetoric (including any tendencies for duplicity and lies contained therein), and character. This moral responsibility is clearly not of the same caliber as the moral responsibility of the politician who actually inflicts the harms, or the enforcers who act on his behalf. Furthermore, because the moral responsibility of voters is always highly dispersed, it is impractical to design appropriate restitution for it. Rather, the sole practical remedy is for the voters in question to recognize the mistake of their prior actions and, in the future, to work to the extent of their abilities to undo the harms of the winning candidate’s actions in office. For instance, a person who recognizes that he was deceived into supporting a “lesser evil” who won can focus his efforts on defeating this politician or similar politicians as the next election approaches. This person could also work at persuading others not to make similar mistakes.

The most reliable way to avoid adverse moral responsibility in voting is to vote for a candidate whom one considers to be an improvement over the status quo in absolute, not relative, terms – and without regard for how others might vote. Morality is not based on consensus, but on objective truth. One’s own understanding of objective truth, and the continual pursuit of improving that understanding, is the best path to moral action and the habits of thought that facilitate it.

As the survey of voter preferences shows, if voters truly voted in accordance to their understanding of the most preferable courses of action, the American electoral landscape in 2012 would be quite different. For one, the 2012 Presidential contest would clearly be between Gary Johnson and Barack Obama, rather than between Obama and Mitt Romney.

Not Enough Inflation? – Article by Tyler Watts

Not Enough Inflation? – Article by Tyler Watts

The New Renaissance Hat
Tyler Watts
July 15, 2012

Two wrongs may not make a right, but a second dose of poison might just cure the first dose. That’s at least what Paul Krugman, America’s most prominent left-wing economic pundit, is saying about an untapped remedy for our economic woes. In his April 5 New York Times column, “Not Enough Inflation,” Krugman repeated his claim that “a bit more inflation would be a good thing, not a bad thing.”

If you’re wondering how progressively higher prices for everyday goods could help any household get ahead economically, let alone contribute to overall economic recovery, you’re in good company. As all econ-principles students know, inflation is caused by an increase in the supply of money relative to money demand. The increase in consumer goods prices—that’s how the layman defines and experiences inflation—is really just a symptom of the reduced purchasing power of money caused by the increase in its quantity. The higher prices for all goods in turn mean lower real incomes for consumers—which is all of us—not to mention that inflation is also typically symptomatic of the boom-bust business cycle and can cause significant widespread economic damage. In its most severe forms, inflation can wipe out people’s monetary wealth and bring commerce to a halt.

But smart guys like Professor Krugman aren’t mere monetary cranks. They know that high inflation is economically dangerous. What they’re asking for is just a small, temporary dose of fresh money to inject some new life into the economy. There is a kernel of truth to this inflationary prescription. As the Scottish philosopher David Hume explained in his 1752 essay Of Money, prices for different kinds of goods react differently to new money entering the economy. Generally speaking, commodities or consumer goods prices will rise faster than wages. So for a manufacturing entrepreneur, for instance, who employs many workers, inflation will cause output prices (revenue) to increase relative to wages (costs), bringing an increase in profits that will induce an increase in output. Therefore, in Hume’s terms, an increase of money “must first quicken the diligence of every [entrepreneur], before it increase the price of labor.”

This “sticky wages” effect is what economists like Hume, John Maynard Keynes, and Krugman have in mind when advocating inflationary stimulus. Krugman also notes that “parts of the private sector continue to be crippled by the overhang of debt accumulated during the bubble years,” and that “modest inflation . . . by eroding the real value of that debt . . . [would] help promote the private-sector recovery.” So higher inflation not only increases the demand for labor, but can also help clean up companies’ and individuals’ balance sheets, giving them the ability to ramp up their hiring and spending. What’s not to love about this miracle elixir?

There are two big problems with inflationary stimulus. The first involves the process dynamics of the market economy. The inflationists tend to omit the rest of the story, which involves the long-run effects of new money. New money will eventually increase all prices—even wages—meaning the stimulus effect can only be temporary. For if entrepreneurs read the price increases not as mere inflation, but higher demand for their products (as the inflationists hope), they are liable to make investments to expand their production capacity. Once the inflation effect peters out, once rising wages eventually push profits back down, they find that extra production is no longer profitable. The expansion can’t be sustained without more inflationary stimulus.

In a rising inflation environment, moreover, people will eventually come to anticipate further price increases. Workers demand upward wage adjustments in advance, and entrepreneurs anticipate rising costs and thus scale back their expansion plans. Once people catch on to inflationary stimulus in this fashion, larger and larger money injections (that is, higher inflation rates) are needed to merely maintain output levels. At some point, the high, rising, and volatile inflation rate itself becomes a drag on the economy. Miscalculation of next year’s, or even next month’s, inflation rate could spell disaster for entrepreneur and worker alike. As inflation heats up, it can actually drag investment down, as people seek to shelter their wealth in “sterile” assets like gold. Inflation, instead of a stimulus factor, becomes a source of economic confusion and frustration. Iconic images of people hauling wheelbarrow loads of money to buy a loaf of bread in post-World War I Germany remind us of the potential economic turmoil of unchecked inflation. This of course is not what Krugman has in mind, but we should not forget that the mightiest river begins as a trickle.

The second big problem with inflation is a moral one. Along with causing economic confusion, inflation redistributes wealth. The key fact here, again, is that not all prices rise immediately when new money enters circulation. People who are first to receive the new money get to spend it before prices go up. Those last in line see prices go up before their own incomes do. Inflation also redistributes wealth from lenders to borrowers, as Krugman indicated, by reducing the real value of debt. But Krugman conveniently ignores the corresponding fact that, whenever a borrower’s real debt burden is eased, a lender’s asset value is eroded. Thus to use inflation as a partial bailout for borrowers is to harm lenders and investors. This is happening already—even at “mild” inflation rates that are too low for Krugman’s tastes, real returns on investments like bank CDs are driven into negative territory.

Through these redistributions of purchasing power, inflation acts like a tax: a tax on savers, on investors, on those at the very end of the monetary policy food chain. Ironically for Progressives like Krugman, this inflation tax arguably hits the poor and uneducated hardest. Educated, economically sophisticated people know the warning signs of inflation and know how to shelter their assets—as attested by the flurry of gold bullion dealers’ ads on cable news and AM radio. The poor are much more likely to be wage earners whose incomes tend to lag inflation, or pensioners who, even with annual cost-of-living adjustments, can still see consistent reductions in their purchasing power.

Nonetheless, Krugman and the inflation party don’t understand the free-market camp’s arguments against inflation. He accuses us of “obsessing” over inflation, while he thinks the Fed should focus on curing unemployment. Even conceding that inflation can provide a temporary, halting employment stimulus, the objection remains strong. It comes down to the fact that inflation is a big lie—or, should we say, a million little lies, because inflation distorts all prices and thereby hinders their crucial function of giving entrepreneurs and workers the correct information and incentives on which to make the best economic decisions. Inflation’s promises of faster growth and greater wealth are illusory. Like alcohol or drug abuse, every high begets a crash that demands larger and larger doses to maintain the effect. Inflation is a dangerous medicine that stands to do the patient more harm than good.

Tyler Watts is an assistant professor of economics at Ball State University and the winner of the 2012 Beth A. Hoffman Memorial Prize for Economic Writing.

This article was published by The Foundation for Economic Education and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.