Republicae: The Degenerative Nature of Keynesian Economics

Thanks to everyone, I so appreciate the majority of comments and please continue to visit Nolan Chart. I have returned for the moment to offer what I hope will be a substantial answer to some of the questions regarding the differences between Keynesian Economics and Austrian. As most of us know, there are substantial differences and effects. I have also included a rather lengthy discussion on interest.

“Neither Austrian nor Keynesian theories are sustainable - both share a common terminal flaw that is degenerative. The problem is that both theories cause an exponential growth of interest/debt - which is irreversible - and terminal.”

First, DrKrbyluv, you make several assumptions that are, to say the least, completely incorrect. In order for you to understand just how incorrect your broad assumptions are you must first understand both Keynesian and then Austrian Economics. Then you must understand the fundamental differences between the two otherwise you will end up, as you have, with a very broad statement that is completely inaccurate, to say the least. Over the months you have shown that you have no concept of either, nor have you been shown, by your own words, even the most basic understandings of monetary mechanics, how interest works, what interest is or the functions of any of those principles within an economic framework. You completely ignore, because of your lack of understanding, what interest actually is and how it works. You assume that interest is related to money that is incorrect. Interest has nothing to do with money and is only an element in preferences, time preferences in particular. What we call interest today and the mechanisms of interest preceded the use of money and it was found to take place in the pre-money barter system economies as far back as the late Neolithic period in history. Therefore, it functions formed independently of money, or for that matter independently of debt as we know it.

What is interest? I realize that based on your understanding of it that you associate it with money, but the fact is that interest has nothing to do with money, but with the preferences of people, once you deny that preference you destroy all economic functionality. You have already shown, time and again, that you don’t understand how interest works, much less what it is and the vital functions it performs in a vibrant economy.

Your nonsensical theory rest on several, not just a few, but numerous false assumptions that can neither account for or explain certain phenomenon within an economy associated with the mechanisms of interest or the fungibility of money as it flows through an economy. Now, while I am totally against the current fractional reserve system and the fiat currency that fuels it, I will attempt, once again, to explain to you the fallacies associated, and apparently so engrained, in your thinking.

At this time I will restrict the subject to the current banking system for simplicity sake. You assume that because new money is created when a banker issues a loan that only the amount of that loan is created and, according to your theory, the interest that is associated with the amortization of that loan is not created. Thus, based on your linear logic, the interest must therefore come from somewhere; otherwise the entire system will collapse because there is not enough money in circulation to pay both the increasing amounts of loans and the interest to retire those loans. Thus, your theory assumes that there is an exponential multiplication of debt and interest that consumes the amount of money in circulation eventually leading to a collapse.

Unfortunately, you neglect, once again, several factors involved in monetary mechanics that you neither address nor are capable of explaining through your linear and generally irrational theory. So, where does the money come from to pay the interest? According to you it wasn’t created when the loan was created so there is not enough to retire the loan or all the loans in existence and collapse of the system is due to that fact. So, based on your understanding, when the bank lends $1,000.00 to a client at 10%, it expects to be repaid $1100.00 that is the original $1,000.00 principle and another $100.00 in interest. Essentially, based on your theory there is a 1:1 ratio involved in the creation of debt/interest, since the interest is not created by the loan itself, but required in the repayment of the loan. Based on your theory there is not enough money to service both the principle obligation and the interest obligation. The fact is that you must completely ignore the fungibility of money to maintain your theory and that is simply ignorant.

First, money is not stagnant as your assumptions must conclude to maintain your theory, money is simply a means of exchange and its constantly moving throughout an economy, thus is may serve one purpose today and the same money flowing through the economy will serve yet another purpose tomorrow. The only way your theory could be possible is if money never exchanged hands. Under our fiat monetary system every dollar is loaned into existence, but not at the same rate nor with the same terms of repayment, thus the time value of money varies based on the type of loan that is processed. In terms of reality, since money does not remain in a stagnate state, but is in constant flux within an economy it does not take new money to pay off interest bearing loans, even though the interest was not created at the same time as the original loan itself. Now if you really want me to break it down for you in economic terms I would be more than happy to do that for you, but hopefully this time around you will crawl out of that little box you have created for yourself by these nonsensical theories and actually study for yourself. I believe I have recommended you several books that would completely enlighten you not only in monetary mechanics, but also in the functions of capitalism, including the necessity of interest.

Now, to make this simple and show you that interest is essential and not associated with money, but is a time preference that functions within an economy and is necessary for economic health, I will give you the following example to ponder. Interest began prior to the use of money; it began in the barter economy.

Say there was a baker who made bread everyday and because this little story takes place in a society prior to the use of money, the baker barters his bread for other products he may need. One day an apple grower came to the baker and wanted 10 loaves of bread, but the problem was that while the baker was willing to barter 10 loaves of bread today for 6 baskets of apples today, but the apple grower would not have a crop for 6 months. The apple grow said he was willing to “pay” 6 baskets of apples to the baker, but that he wouldn’t have those apples until a point in the future. Why should the baker accept 6 baskets of apples in the future when he could easy barter those 10 loaves of bread today for something he needed today, say like 6 dozen eggs, or some other commodity that was ready today for barter? He has a preference, based on the barter price today, but he is willing to consider his time preference in the future and since the apple grower cannot “pay” him today the baker is willing to barter the 10 loaves today to the apple grower if the apple grower, who needs the bread today, is willing to “pay” 8 baskets of apples in 6 months to the baker for the 10 loaves today. It would not be prudent for the baker to simply turn over 10 loaves of bread to the apple grower today while losing the present value he has to barter that same 10 loaves today to someone else for a product, like 6 dozen eggs which have present preference over waiting for 6 months for the apple grower to barter him 6 baskets of apples for those 10 loaves because it would not be worth it to the baker to lose the ability to “profit” today by waiting for the same number of baskets of apples in the future. It would however, be a potentially good barter, based on time preference, for the baker to barter those 10 loaves today for 8 baskets of apples 6 months into the future.

Now, to put that in modern terms, outside the Exploitation Theory, which you adhere to concerning interest. I will take this further. Money resulted from the uncertainty of human action and preferences. Interest came about based on several preferences found within humans, and it came about in the barter stage of economic development prior to the development of money. The various preferences that brought about the need for interest was not only time preference, which happens to be an essential element of economic exchange based upon uncertainty, but also as a means of determining risk, which is the hinge of a capital economy, as well as a barter economy for that matter. Like the baker, a person must determine risk based upon both present need and availability verses future need and availability. Without this mechanism the potential for exchange cannot exist. Additionally, the baker had to determine if the future price of 10 loaves of bread would indeed still be worth 8 baskets of apples in the future, it might be that his risk of bartering those 10 loaves today to the apple grower will not actually cover his cost of 10 loaves in the future with only 8 baskets of apples. The baker must also be aware that he is also taking risk by giving 10 loaves of bread to the apple grower today and the apple grower loses his entire crop of apples in 6 months; thus he must once again determine the risk associated with his willingness to give over those 10 loaves today for 8 baskets of apples 6 months into the future. Now, had the apple grower had 6 baskets of apples today then there would be no risk and the voluntary exchange for 10 loaves of bread today would have taken place with no questions of risk asked about the transaction.

Likewise, with money, no different that the bread or the apples, both are mediums of exchange in a given economy. Now, with money there are also other factors concerning person’s goals, whether personal or business, and how those goals will be reached. Additionally, there is the risk, with money, like the risk with the bread and apples. Essentially, there must be a consideration which demonstrates a preference for present value over future value. Present goods, or money is always more preferable to future goods, or money. If you can exchange your money today for something you need today then you will do so. If however, you need something today without the ability to pay for it you either must wait until you earn the money or you must intervene on the time preference of someone else, such as a lender. Now, a lender, whether institutional or a personal associate, would rather use their money today if it brings about a fulfillment of present preferences, however if they lead it out and assume the risk associated with that act, then they must also assume the difference in time value. Since taking present money and lending it renders that money void of both exchange and investment, the risk of lending must take into consideration all the preferences between present and future values. Essentially, interest represents the constraints of time preferences, thus a man will exchange a present good, such as money against a future good, such as money loaned, only if he can anticipate that the future amount will be of a greater value to him. Without this time preference function, the economy would not function because there would only be present consumption without regard for any future return, the reason for that is the risk would simply be too great to assume a loss today for a potential future repayment without that risk being accounted for in the equation of a loan.

Now, in a free market, the rate of interest is basically nothing more than the complete sum of all time preferences within a society. Thus the supply of goods or money offered in exchange against future goods and services are determined by market movements as individuals determine their needs, their desires, their goals and whether they are willing and able to pay for those things today or, if not, then are they willing to assume the premium of someone else’s time preference to lend them the money to buy the goods today, but repay over time. Thus the demand for present goods must be capable of yielding future returns, if not then there is no reason for the borrower to borrow and there is no need for the lender to lend since there would be no just exchange between the two time preferences of each person, the borrower and the lender.

So, time preferences are therefore, inherent in every human action and that inherent time preference manifest itself in what we know as interest. Interest is really nothing more than the discount between present goods against future goods. Interest, contrary to your understanding, is not merely interest on money, it is not income that is derived from the utilization of capital goods in the economy, but it is a correspondence between labor, capital and property. In a very real sense, interest is no different that rent on property owned, in fact it is the same thing. Rent, like interest, plays a role in the yield of labor and capital goods, without it you would not see these elements performing as they should since, unlike your assumptions, there is no homogeneous source of income. Interest however, does stem for a homogeneous source and that source, whether it is interest on durable goods or interest on consumption credit is the naturally occurring phenomenon of time preference of higher valuation of present goods as opposed to future goods. Interest is not a characteristic of capital only of time preferences which allow the judgment of timing and risk associated with various economic elements that are essential for a healthy and prosperous economy. Once again, interest is basically nothing more than the ratio of value that is placed on desire/satisfaction in the present verses the desire/satisfaction in the future. So, the rate of interest, in a free market at least, determines both demand for and the supply of both capital and capital goods, without it that economic law would not, could not function. Interest determines how much of the available supply of capital goods will be devoted to consumption now and how much will be needed in the future for future consumption. Interest is a gauge of multiple levels of economic functions, from employment to production to consumption.

Now, while in a free market economy people do not necessarily save or accumulate capital because interest will be paid, nor should interest be considered a type of compensation rewarded to the saver for abstaining from present consumption, but it is a mutual valuation, a ratio that allows for the judgment of how much present goods and utility is valued verses how much future goods and utility is valued.

In a free market economy, as Austrian Economics support, the banking industry or loan market does not set interest rates. Sounds radical doesn’t it? It is the market and market forces, along with the multitude of time preferences exhibited in normal economic functions that determines the rate of interest. Nor do the banks control the interest in a free market economy, nor does the government and we certainly wouldn’t have a central banking system in a free market economy.

Interest, being an inherent time preference of human actions is essential to any valuation of external things that time preferences cannot be legislated away, forbidden or eliminated from the economy because it has nothing to do with money, but everything to do with human action and what people prefer and the time frame in which their preferences manifest in the market. When you come to understand that interest, particularly in a free market, is not the result of money, but the result of human preferences, desires and wants that lead to a mechanism used to satisfy those preference, desires and wants.

I could go deep into interest and savings, the essential conjunction between the two, but that would complicate matters beyond your willingness to consider, that based on my past discussions with you. However, I will say that in a free market, sound money economy, no supply of loanable funds could exist without there being previous savings. What are savings? Basically, it is the excess of current production over current consumption and is based again on time preferences and as well as, other preferences including a person’s present and future needs desires and goals. Indeed, there would be no demand for loanable funds if a person, judging his time preferences, did not perceive some opportunity to employ those funds in hopes that he would be able to both repay those funds and benefit from the funds he borrowed.

Without interest, which is simply a measure of time preferences in our society, there would be no measure of risk that a person or business would be able to use to determine the degree of his preferences. I realize you can’t understand this next statement, but without interest we would consume our goods because there would be no measure to utilize to determine either present value over the risk of future value. What you are asking for would lead to a primitive subsistence existence because no one would lend without the ability to determine risk and protect themselves against any possible risk. Business would not exist, whether it was a money based exchange system or a barter exchange system, no business would extend present goods without the measure of risk associated with future time values. Without interest, there would be no excess production over present consumption, there would not only be no need for it, but no mechanism to bring it about. There is always a price paid for buying time, either in terms of risk, in terms of need or in terms of desire. To think otherwise simply indicates an economic and monetary naiveté that borders on willful ignorance.

Time preferences, as expressed in interest, are also directly associated with employment and income, yet it has nothing to do with money, as I said the money represented by interest is just the medium of exchange for time values between present value and future value. Once again, I understand that you don’t understand what I am saying or how these functions interact within an economy, especially a free market economy, but the fact is that interest and money are independent and is not a monetary phenomenon, but a human phenomenon based on numerous preferences found within human beings.

In contrast to money, time preferences expressed and measure by interest, brings about a particular equilibrium within the economy that could not be attained without it even if there were no money used as a medium of exchange. Again, I realize that you are, based on your comments here and on other forums, incapable of wrapping your mind around a multi-dimensional logic, but I sure hope you try to escape that box you have enclosed yourself with.

You see, without interest there would be no ability for the economy to maintain the equilibrium necessary to function properly. In fact, without interest there would be no savings, no investments, and no reinvestments because without interest there would be no positive rate or hope of return on risk. As we are now seeing, even in this artificially managed economy, when the rate of interest is lowered to the Zero Bound, capital consumption is resulting and the entire system is being thrown out of equilibrium.

Interest brings and allows a certain degree of certainty over uncertainty, in other words there is a degree of trust associated with interest, both on the part of the lender and the borrower. Interest is the bond of agreement on the value of time, without it there would be, there could be no agreement on time value or the risk associated with that value. All consumption and investments are determined by time preference and time preference is what created interest, whether in a monetary exchange system or a barter exchange system, time preference an essential function for an healthy economy that will produce prosperity, if that economy is allowed to function as it should.

In a real economy, the level of the actual money stock has no effect at all on interest. This is evidence of the fact that money does not determine the rate of interest, time value determines the rate of interest in a free market economy. As I said, money and interest are not associated, but are independent of each other in their functions in an economy. Since interest has nothing to do with money, interest never causes inflation or deflation, only the supply of money causes those or in the case of supply and demand, you will find inflation or deflation being effected, but never interest since it has anything to do with money, but time preferences. That is why it is so damaging when the Federal Reserve manipulates interest rates; they are actually manipulating time preferences which will always, without exception, cause booms that are always characterized by mal-investments leading to economic dislocation. While it is true that the supply of money can affect time preferences within a society, as we have seen in this latest round of boom/bust cycles, it is not the determinate factor of those preferences. The artificial increase or decrease in the money supply can and does distort the equilibrium within the economy, as we have seen.

It is important to understand that in a free market economy, the rate of interest is completely determined by the market rate of time preferences and that is why the market will always seek that equilibrium, even under the pressure of artificial influences such as the FED.

“With both theories, there will always be more debt than money since only the principal, none of the interest, is ever issued as money. Both systems require that the amount of new debt must continuously grow.”

Now, concerning that statement, how do you arrive at such a conclusion? If you were indeed aware of monetary functions, particularly under a sound monetary system as advocated by Austrian Economics then you would be instantly aware that such a statement is complete and utter nonsense. Both systems do not require the continuous growth of debt, on the contrary, the Austrian system requires monetary responsibility due to the fact unlike fiat money which is a double liability; gold money is a double asset. That is something that you simply are unable to address or consider if your theory is to hold even the miniscule amount of water, which it doesn’t. Under the Austrian Economic system, gold and the supply of gold is the restraining value on debt, both government debt and personal or business debt. Therefore, contrary to your board and completely baseless assertions, debt is restrained under the Austrian Economic system. Capital however is not and capital is what builds prosperity, money does not. For if money was the key to prosperity then we would all be wealthy due to the fact that the FED has printed so much of the stuff, but money is only the medium of exchange used to create wealth by the production of capital.

“Both theories contend that the banks and various other lenders spend the interest charges collected back into circulation. No doubt some of the interest charges collected will end up back in circulation - but that misses the problem.”

I am not sure where you get your information, but if I were you I would toss it out the door. Your assumptions are once again erroneous. In terms of banking, what happens to the interest collected on loans? Based on your comments you think it must accumulate in a vault somewhere, but the truth is that interest is paid, in part to shareholders in the form of dividends, paid to bank customers who hold savings instruments, paid to various vendors that provide services to the banks and it is also invested in other assets by the banks. You must, based on your dogma, exclude the fact that the financial sector, including banks, are also businesses, thus interest payments must always be included in a businesses gross profits. Like all businesses, utilities must be paid, taxes must be paid and like all businesses, salaries and wages must be paid. Now according to you the money collected as interest doesn’t enter back into circulation, as least in your mind, to any substantial degree, but that is simply ignorant of how business operates and how funds flow from businesses into the economy. When interest is collected as money, it remains fungible in the economy and continues to circulate performing the functions of exchange.
Remember, money is not stagnant, nor is interest when it is collected.

Such a statement must preclude even the most elemental degree of logic, not to mention the most basic knowledge of economics. Interest payments are not, nor must they come from future debt, that is absurdity to even think such a thing and denies the most basic functionalities of economic movement. Even under the Keynesian theory that has created this fiat monetary system that is not the case. You totally ignore the process of capital production within an exchange economy where money is fungible and interest is based, not on money, but on time preferences. You fail to understand, nor is it possible for your fallacies to explain the fact that in an exchange economy the objective exchange value of a variables, such as goods and services, enters as economic calculation that reflects both value and time preferences.

You really have no clue what you ask for when you ask for an interest free economy and there is absolutely nothing in the simplistic and false theory that you propose that can come close to explaining how you would do away with interest, since it is not connected with money but with human action and the effects that would have on the economy of man. The theories you parrot are completely filled with insoluble contradictions to which you can offer no adequate answers, solutions or rebuttals that would actually address the issues that I have raised.

If any of you need to ask me a question about anything at all, please don't hesitate contacting me via my profile page. I will try to assist anyone with any question if at all possible and would love to hear from any of you. Just because I have taken a break from the DP doesn't mean that you are out of my heart or mind.

LONG LIVE THE rEVOLution!

http://www.1776solution.blogspot.com

"Don't worry, we've thrown out the Weimar Republicans and elected the Zimbabwe Democrats." Billy Joe Allen

The fatal flaw is your superficial understanding of Austrian Economics. I don't mean this in a derogatory way---I would just suggest that you read the work of Mises (Human Action and Theory of money and Credit). These guys actually have thought of the problem of which you speak.

You state, "The problem is that both theories cause an exponential growth of interest/debt - which is irreversible - and terminal."

In a true Austrian free market ...
reversability of growth in interest/debt is forced by the market at times.

In a Keyensean market ...
there is malinvestment followed by regulations that prevent a correction.

All markets reflect humanity ... hence ... there are flaws.

In an Austrian market they are not only allowed to be corrected, they are forced to be corrected. In a Keyensean market they are not only prevented from being corrected, they are forced to continue.

Do not fall into the incorrect assumption of a "zero sum game".

WAHOR!!
http://www.dailypaul.com/node/48994

Wow, you still don't get it!

http://spreadsheets.google.com/ccc?key=p7jSfNelm7FDJ47ek1DvxEQ&hl=en

Copy and paste that into a new spreadsheet, and play around with it a bit. You can create debt, charge interest, pay off the debt with interest, all without changing the amount of money in existence, and without perpetually increasing debt!

It's so ridiculously simple, yet, for reasons unknown to me, you still do not understand it!

The amount of debt must perpetually grow.

That is absolutely wrong!

He has been there for a while ...

well before he came here ...

I love his writing ...

but I would prefer to read it here ...

hopefully he comes back.

WAHOR!!
http://www.dailypaul.com/node/48994