Modern Monetary Theory: The Austrian Contribution

0:00Okay, this morning's lecture is on the topic of modern monetary theory, the Austrian contribution. And it's in monetary theory that the Austrians diverge most from the mainstream. At least in micro theory they tend to use the same terminology, supply and demand, marginal utility, entrepreneur and so on. But in monetary theory, the Austrians approach it on a micro level. They don't use the same conceptual apparatus as mainstream neoclassical economists do. They don't use, for example, the quantity theory. They have serious objections to the quantity theory.

0:46What the Austrians have tried to do, and when I talk about Austrian monetary theory, by the way, I'm really talking about the contributions of Mises and Rothbard. They are, aside from contributions in business cycle and international monetary economics by Hayek, they are the really only Austrian monetary economists of the 20th century. It was their work that resulted in the development of Austrian monetary theory. And remember, both Mises and Rothbard, to some extent, started their careers as monetary theorists. Mises' first book in economics was The Theory of Money and Credit, which was mistranslated, as Guido Hülsmann has informed us, and should have been translated as the theory of fiduciary media, that is the theory of bank deposits and bank notes, unbacked by reserves and Rothbard one of his earliest books or in this case a booklet was on what has government done to our money which I mentioned as a very very not just a primer on money but a very important contribution to the theory of fiat money also his America's Great Depression which came out in the

2:10same year is really applied monetary theory and there's a long and important and prior to that chapter there are two other chapters which lay the foundations for monetary theory so both were monetary theorists par excellence so as I said Mises' book, The Theory of Money and Credit, is really what we call the locus classicus, the classical source of monetary theory and monetary theory. The classical source for Austrian monetary theory, for the praxeological analysis of money and prices. Austrians from Menger to Wickstede all developed, as we saw, the microeconomic aspects, that is, value theory, price theory, and distribution theory, or factor pricing theory.

3:08But they did so in a border context, and they realized that the main point or objective of economics was to explain money prices. But they never were able to integrate satisfactorily money, monetary theory with value theory. And Mises, in fact, did this. Now, after the Marginalist Revolution, the development was called the neoclassical dichotomy later on, but it was really the neoclassical dichotomy, which means a split by the non-Austrian economists. So if you look at non-Austrian textbooks of the late 19th century, early 20th century, you'll see that money is pushed to the end of the textbook in separate chapters and the analysis uses different concepts.

4:03It doesn't use good old supply and demand, it uses macro, what might later come to be which would be called macro-concepts, such as the quantity theory. In this treatment of the non-Austrians, money was really treated like a veil. It's a veil that obscured the real processes of the economy. Production was done with real factors of production. Exchange was really ultimately, even though we exchanged our labor services and our goods against money, Production was the exchange, ultimately, of goods for goods or goods for services. Money was only an intermediary and didn't affect the real processes, unless it got out of order.

4:49If there was a rapid inflation or a hyperinflation, as it was in Germany, yes, then that could affect and distort the real processes of the economy. Or if there was a sudden and unexpected deflation, as there was in the early 1930s, there could be problems with the real economy as a result. as a result. That much was admitted. But it was an ad hoc explanation because all along money was kept separately in the regular analysis. As I said, the typical approach was the quantity theory of Irving Fisher, which was written out as a very simple equation. the quantity equation, money times the velocity of circulation of money, the number of times that money turns over, the average unit of money turns over in a given year will equal price. So very simplistic way, if the money supply is is $100 and if on average those dollars are spent in transactions, let's say, five times during the year, the velocity of circulation money is therefore five, and let's say that the good that's produced is pizzas,

6:22And so, price of pizza is 10, well then there would be 50 pizzas produced and sold on the market, okay? So the side in which we have spending is $500 spent in the economy, that is a money supply of $100 that turns over on the average five times a year. $500 spent per year, and the income received by the producers of, let's say, pizzas is the $10 per pizza times the 50 pizzas that are sold in this case. So it was a macro concept, or a macro approach, this quantity theory. Now, this led to the implication that, given that velocity was pretty much fixed by various institutional factors, the number of times per year workers were paid, the amount of money that people liked to hold, and so on, certain business practices.

7:25We assume that to be fixed, and we also assume that the number of pizzas produced were fixed by the amount of labor, to measure the amount of capital goods and the type of technology in the economy. Well then, the only thing that could change, if there was an increase in the money supply, let's say the money supply doubled to 200, well then prices would double to 20. Which would mean that both sides would now be 1,000. Doubling of the money supply would bring about an exact doubling of the price level. or to put it more generally, a given percentage increase in the money supply would result in the same percentage increase in the price level.

8:10And that was how the value of money was explained, and again I'm simplifying tremendously here, by the non-Austrians. Now Mises succeeded in repairing the split between monetary theory and value theory. And let's first start with what Mises sought to accomplish. He wanted to integrate the theory of money into the overall framework of supply and demand, which for the Austrian meant that you had to explain demand and supply ultimately by marginal utility. You had to apply the theory of marginal utility to the explanation of why people held money, why people demanded money.

8:55Now, Menger and Boehm-Bawerk both made a start towards this, but neither developed any sort of complete theory. So let's start with what Mises saw as the definition of money. First of all, you have to have a definition of what the supply of money is. Mises defined it theoretically, he took his definition from Menger, as the general medium of exchange. That was the primary function of money. The other functions that we hear about in our textbooks, store value, the standard of deferred payments, or we might say also the unit of account or store value, And all of those functions are derivative from the main function of the medium of exchange.

9:49So when we say it's a general medium of exchange, we mean that people routinely and universally accept money for the most precious items that they have, including their labor. So no one thinks twice about working for, let's say, $500, even if they're paper dollars. We readily accept that because we have confidence that we can turn around and use those dollars to purchase the things that we have placed the highest values on. Now generally, when Mises wrote, before he wrote, economists generally distinguish between banknotes and token coins on one hand, and demand deposits and checking account balances on the other hand. They believe that banknotes and token coins were part of the money supply, but that demand deposits or checking account balances were not.

10:43So the money supply, before Mises wrote, was generally defined as consisting of the standard money, which was either gold or silver, plus banknotes that were denominated in fixed amounts of gold and silver, and any token coins that were issued. They did not consider checking accounts as part of the money supply, for the most part. Certainly Irving Fisher, who Milton Friedman referred to as the greatest economist that America has produced, did not consider checking accounts as part of the money supply. Something that we do today, as every economist would include today. So, Mises came up with a taxonomy of money. He based himself on Menger's essentialist approach.

11:28And he summed that approach up in the following way, he said the greatest mistake that can be made in economic investigation is to fix the tension on mere appearances and to fail to perceive the fundamental difference between things whose externals alone are similar or to discriminate between fundamentally similar things whose externals alone are different. So Mises came up with a new taxonomy of money and let me show you what that taxonomy looked like, diagrammatically. Mises started with what he called money in the narrow sense, which we might think about as cash.

12:20Money could either be commodity money like gold and silver, or it could be credit money. That is, it could be bank notes that were previously redeemable in gold and silver, as was the case, for example, in Great Britain before 1797. Great Britain went off the gold and silver standard during the Napoleonic Wars and the paper pound became the money or cash in the system because banks were permitted to suspend and payment in gold and silver, including the Bank of England. So the paper pound became money from 1797 until 1821. But everyone expected that after the war ended, the paper pound would once again be convertible into gold and silver.

13:11So, in the case of credit money, it's not just a supply and demand for the money that determines the value of money. We'll talk about that in more detail. It's also the expectation that that money will be redeemable in the commodity money at sooner or later point in the future. Finally, fiat money. Fiat money is a paper money in which there is no prospect that it will ever again be convertible, or no immediate or plausible prospect that it will be convertible ever again in commodity money, Money, and such as the money that we have today, okay? So Mises distinguished those three types of basic cash in the system.

13:56His next category was money substitutes. He said, given that we have either commodity money or credit money or fiat money, let's say we have a commodity money, people deposit that in a banking system, okay? Once you have a banking system, people will deposit part of their cash in the banking system. That part of their cash that is completely backed up, I'm sorry, that part of their deposits, whether it's in exchange for banknotes or checking account deposits, that is completely backed up by cash he called money certificates, that are not backed up he called fiduciary media. You trust that when you come in to redeem your bank note or your checking account deposit, that it will be there.

14:49He then identified the category of money in the broad sense, or MBS, and in today's world that would be known as M1. And what he said was this, he said that that would be equal to money in the narrow sense, In a sense, that is, under a commodity system, all the gold coins in the system, plus money certificates, that proportion of the banknotes and deposits in circulation that is completely backed by gold, and let's assume we have a gold standard, plus fiduciary media, that proportion of the banknotes and deposits that are not backed, minus bank reserves, because the bank reserves would be double counting. They are backing up the money certificates.

15:34So part of the gold, you have to subtract the gold that's being held by the banks from the total amount of gold coin in the system. Because that's being substituted for by the money certificates. Now let me just give you a simple example. If there's $10,000 in gold coin and there's $5,000 in bank notes and deposits and banks hold $2,500 in bank reserves, that means that there's a 50% reserve ratio. What would be the total money supply? Well, it would be the, in a broad sense, and this is what Mises thought of as the total money supply, it would be the $10,000 in gold, plus the $2,500 in money certificates, those backed up by gold, plus the $2,500 in the money that was simply created out of thin air by the banks, minus the $2,500 that was backing the money certificates.

16:28So, in total then, you would have $12,500 in the system, so that the banks would have brought about, through their lending operations, in this case, a 25% increase in the money supply, that would have driven up prices roughly by 25%, maybe more, maybe less, okay? Mises did not believe in the quantity theory in which there was strict proportionality. Another way of adding it up was simply to take the $10,000 worth of gold coins and add to that the $2,500 of fiduciary money that you would get the same answer. So this is Mises' new taxonomy of money. What was innovative about it was that Mises was the first one to say that money, or a definition of money, in this case money in the broad sense, included not just banknotes, but any checking account deposits, whether they were backed or unbacked by the cash in the system.

17:38There were some other 19th century economists, particularly in the United States, that recognized the fact that checking account deposits, just like banknotes, were part of the money supply. So, Mises points out that, look, whether you pay in banknotes or with checking account money, the effect is the same. Both banknotes and a check written on your deposits are final means of payment. You've completely discharged your debt to the seller or to the creditor. So, since the two things function the same, since banknotes and checking account deposits function the same, are essentially the same in the Mangerian terminology. They, in fact, must both be part of the money supply.

18:26It would be inconsistent to include bank notes and not to include checking account money.

18:37Now, what was interesting was that Mises classified most historical periods of paper money, Not as fiat money, he didn't consider it to be fiat money, he considered it to be credit money. Because in his experience, every single period in which paper money developed, whether it was during a war or during an emergency, always resulted in the currency being eventually redeemable again in gold or silver. So people always had this expectation that eventually the government after the war is over, after the king has bankrupted the country and has caused a hyperinflation as in France by issuing paper money, eventually the paper money is going to be in some way tied back to gold or silver.

19:35So Mises made the following statements. This is very interesting. He admitted theoretically that we could have a purely paper money. But he didn't think that he ever really saw an actual instance of this, in which paper money was a fiat money, a money that was simply, as Murray Rothbard points out, a pure name. A fiat money is literally a pure name. The dollar is a pure name. The government could stamp that on here. It could stamp it on your bottle of water. If it stamped $100 on that bottle of water, legitimately stamped by the Treasury, that would circulate. Because it's the name which the government monopolizes under fiat money. That is the essence of money.

20:23So Mises, again, theoretically admitted this, so did Wieser. They admitted that could happen. Mises even said that at some point in the future, it may be the case that the commodity money gold loses its non-monetary functions, that is, that people no longer like or use gold as jewelry or industrial purposes, so that gold becomes simply a money commodity. But even in that case, it's not a fiat money, it's still, its supply is still controlled by the market, it's still controlled by the cost of producing gold. So let me just read you Mises' statement regarding fiat money. Mises says it can hardly be contested that fiat money, in the strict sense of the word, is theoretically conceivable, meaning a money that is a pure name, that is monopolized by government, and that people have no expectation of it ever being convertible again into gold.

21:23He goes on to say whether fiat money has ever actually existed is of course another question and one that cannot offhand be answered affirmatively. It can hardly be doubted that most of those kinds of money that are not commodity money must be classified as credit money, but only detailed historical investigation could clear this matter up. Even as late as 1966, in the third edition of Human Action, we've had from 20 years of the Bretton Woods system in which Americans could not convert their dollars into gold, in which foreign governments were permitted to, but Americans were not. In fact, Americans were not able to convert dollars into gold since 1933.

22:08So, yet Mises still was reluctant to admit that the dollar was a pure fiat currency. And he says, this is in Human Action, it is not the task of catallactics, meaning economics in a narrow sense, but of economic history to investigate whether there appeared in the past specimens of fiat money or whether all sorts of money which were not commodity money were credit money. So he, okay, then in fact it probably is a credit money, but to clear this question up we do have to have an historical investigation. Mises never explained how the transition occurred during history from commodity money to credit money finally to fiat money.

22:55That was left to Rothbard. Now, one problem with Mises' monetary theory, he did include demand deposits, we're checking account money, as we said, as a money substitute, but he had a problem with savings deposits. Now, as early as the 1920s and even earlier, banks, even though in the small print, If you had a passbook savings deposit, it would say they could require you to give 30 days notice before you could withdraw money from your savings account. So technically it was an investment deposit, meaning that they would make short-term loans with that money. But after a while, because of central bank policy, and certainly in the 1920s and 1930s, savings accounts could be withdrawn on demand at par.

23:50So if you had $10,000 in a savings account and you wanted to go purchase something for $10,000, you could immediately go to the bank and withdraw that money on demand. The bank would not invoke that 30-day clause, that 30-day warning that you would have to give them, that you wanted the money back. So, Mises had an ambivalent attitude towards the inclusion of savings deposits in his broader definition of money. As early as 1924, he recognized that institutional developments had led banks to, quote, undertake the obligation to pay out small sums of savings deposits at any time without notice. So, he was saying that in fact banks were not invoking that clause that you had to give them notice.

24:40And this circumstance, he went on to say, induced small business people in lower-income households to use these deposits as current accounts. He's admitting that people are using them almost as checking accounts, except they simply have to walk to the bank to withdraw the money, despite the fact that they were technically investment deposits. Thus, Mises implied that at least some portion of savings deposits functioned economically as money substitutes and should be included in the broad concept of money. Mises did place much of the blame for the financial and exchange rate instability that occurred in the early 1930s on the widespread treatment of savings deposits as current money, or as he would say, money substitutes.

25:34And he pointed out that this development was actively sought and encouraged by the banks. The banks wanted people to have confidence that they could take the money out of savings accounts at any time. Because that would increase the amount of deposits they got, which could be loaned out and it would increase their interest income. And the central banks made sure that if any of these banks were unable to pay, they were there to bail these banks out, in other words, they attempted though there wasn't any sort of deposit insurance at this point they attempted to ensure that the instantaneous convertibility of savings deposits which the commercial banks promised to their customers would actually be something that people believed in, that people had trust in so Mises points out that it wasn't not money flowing from one country to the other or capital flight in the 1930s that added to the problem of the Great Depression.

26:39What he said was it was this attempt by both central banks and commercial banks to get people to use savings accounts as if they were checking accounts that caused a lot of the problems. So that when people began to fear that, for example, you know, the Austrian bank, the When that collapsed, many foreign firms and governments had deposits, savings deposits they were getting interest on, that they immediately pulled out. And this made the financial situation more unstable than it already was. Despite this brilliant analysis of savings deposits and how they had come to operate as part of the money supply, Mises pulled back from including them in the money supply.

27:25So, in 1966, in the third edition, at one point, he referred to them as demand deposits, not subject to check, but then inconsistently denied that they were money substitutes. Rather, he identified savings deposits as the foremost among what he called secondary media of exchange, which included highly marketable financial assets. He included savings deposits, he included blue chip stocks, he included government bonds, not as money, but as secondary media of exchange that people could easily liquidate. So if you needed cash for a current purpose, you could sell your IBM stock or you could sell your government treasury bill pretty quickly for actual cash.

28:10But the problem is, by then, 1966, we have a Federal Reserve system, we have federal deposit insurance of savings and checking accounts, whereas you're never completely certain of what price you're going to get for your IBM stock or your treasury bill, you are certain that you're going to get the full face value or par value of your savings account. So, you're not selling something. When you go cash in your savings account, you're not selling some sort of financial asset for a price on a market. It isn't a market. All it is is converting a claim to ready cash. So, it should have been counted as part of the money supply. Mises did not do that. That's another improvement that we'll see that Rothbard made.

28:58Now, what about the demand for money? Early Austrians had problems in applying marginal utility theory to money because of what was called by a German who was an anti-Austrian. His name was Carl Helfrich, who became the chairman of the German Central Bank, which was the cause of the hyperinflation in Germany. Helfrich wrote a big book on money and he criticized the Austrians. He said, look, you can never apply marginal utility to money because of the Austrian Circle. So he used this term which has stuck in the literature and which was supposed to be referring to a major failing of the Austrian value theory.

29:44And the Austrian Circle looks like this. This is what Helfrich said. He said, in order to figure out the value of money, let's look at the top, the marginal utility of money. That is, how an individual values money against other goods and services, which would determine how much that individual would hold in his or her cash balance. In order to figure that out, that person has to know the purchasing power of money. That is, what is the value of money on the market? To know how many dollars to hold, you have to know how much lunch is going to be every day during your pay period. How much, I live in New York, how much a subway is going to cost? How much a glass of beer will cost? How much a restaurant meal will cost? How much a shirt will cost?

30:29You already have to know the value of money before you can figure out, let's call it the objective value of money. You have to know the objective value of money, which is the exchange value of money on the market, before you can know the subjective value of money, before you can judge subjectively how much money to hold for the future. And you make that judgment by comparing goods with money. But the money has to have a previous purchasing power. So he went on to say, the marginal utility of money then does determine the demand for money, how much money people want to hold, which, given the supply of money, the demand and supply determines the purchasing power of money, which in turn determines the marginal utility of money. So what he was saying was that, all the Austrians were saying was that The purchasing power of money determines the purchasing power of money, indirectly, so it was a circle, which could not be broken.

31:23Once again, you have to know what prices are before you know how many of these pieces of paper, which we call a dollar, that you want to hold in your wallet, in your checking account, in your savings account. Because if prices were lower, you would want to hold fewer of these dollars, because you could purchase more with each one. If prices were higher, you would want to hold more of these dollars. Each single dollar would have a lower value to you, and you would want to hold more purchasing power. In any case, that was the Austrian Circle. Now, how did Mises get out of the Austrian Circle? He got out of it through something that we call the regression theorem. Can we write that here?

32:10Which was a great theoretical breakthrough. Let me point something out. As J.V. Say said in 1803, In response, the previous economists would claim that human beings could create goods. Say, basically, you said human beings cannot create matter at all. Only God can create matter. Human beings can transform resources and various elements of their environment into other forms that have greater use to them or greater utility to them. But they can't create anything. Well, one thing that human beings can create is new ideas, New systems of thought, new concepts, and Mises created this new theory.

32:59He was a creative genius. Now, what he said was the following. In fact, Helferich has made an elementary error. Because it's not the purchasing power of tomorrow that determines the marginal utility of money today. We have to date these things. What Mises pointed out was that when we make our judgment about how much money to hold for tomorrow, we do so based on what the value of money is today. So let me show you what I mean by that. What Mises did, the purchasing power of money in time t0, which is today, I have the arrows going in the opposite direction, meaning that the amount of money that you demand, that you'll demand today.

34:06Today. So the monetary demand depends on what the purchasing power of money was today. So you see the prices around you, you determine the value of money, the marginal utility of money and so on, or actually let me, because I have these hours going backwards, let's start here. Let's start to the right. The supply and demand for money yesterday, T minus one, determines what the purchasing power of money was yesterday. So the supply and demand for money was yesterday. Now, today what you do then is you look at prices yesterday, before you go into the market, and you determine, based on how much a dollar can purchase, how many dollars you want to hold and how many dollars you want to spend.

35:01Okay, so you determine the marginal utility of money, the value of a dollar in relation to other goods and services. That in turn determines today's demand for money, okay? And given the supply of money, either, let's say under the gold standard, supply and demand determines today's purchasing power of money. So we're not saying that the purchasing power of money determines the purchasing power of money. We're saying that there is a human judgment and choice being made. Human beings are looking back at yesterday's purchasing power. There's always a pre-existing set of prices, of money prices. You look at those prices, you determine the purchasing power of money, you know what money can exchange for on the market yesterday, and you might make a judgment about what it will be tomorrow, but it's always based on what it was yesterday.

35:50And then you determine subjectively how many units of money to hold, which determines your demand for money, and we'll talk more about holding money and so on. And that, in conjunction with the supply of money, will determine today's purchasing power of money. At the end of the market day, there will be certain prices that have emerged that will be different from yesterday's. So the following day, you will do the same thing. You look at, tomorrow you look at what today's prices were, determine the marginal utility of money, which will determine your demand for money, and given the supply, that will determine a new purchasing power of money. Now, the second objection that came up was, well, all Mises has done is come up with a regressus ad infinitum in Latin, Meaning, we explain the value of money by continually going back in time and never ever ultimately explaining where the purchasing power of money came from initially.

36:59So, it regresses infinitely back in time. Well, Mises points out, well, that's not true, because, in fact, the regression theorem tells us that the value of money emerged the day after barter ended. That if you go back again to the last day of barter, when people were only using gold, let's say, for ornamental purposes, for jewelry, for rituals, and so on. Then it was simply the marginal utility of gold on the last day of barter, and you can't really see it there, but I have that as T minus N minus 1.

37:45In other words, let's say we've had N days of a monetary economy. Well, the day before T minus N minus 1, the day before the monetary economy started, on that day, the value of gold, the marginal utility of gold, was determined at that moment by the uses of gold, just like any other good. So when we go out and today you purchase a Wendy's hamburger, your demand for that hamburger, Your decision to purchase that hamburger depends on your value scale at that moment. There is no temporal component in determining the marginal utility of any other good except money. So gold was determined, the value of gold was determined on the last day of border, but the subjective value, which gave rise to demand for gold, and given the supply of gold in the system, you had a price of gold.

38:39The price of gold on the border was in terms of every other good that it exchanged for. So, on the first day in which someone said, you know what, everybody in the society accepts gold or uses gold directly, and therefore I'm going to exchange my goods for gold not because I want to use gold directly, but because I want to go and buy wheat or I want to go and buy a plow. At that point, then, people can take gold and demand it as money because there is a pre-existing purchasing power under barter. So it does come to a close. It is not regressus ad infinitum. The value of money can be traced back, the temporal element in determining the value of money can be traced back to the last day of barter.

39:29Now, a general equilibrium economist who we talked about yesterday, John Hicks satirized Mises' explanation, his regression theorem, and said that well then, money becomes the ghost of gold, according to von Mises, okay? And he meant to be sarcastic. Well, money is not the ghost of gold, but it certainly, the fiat money that we have today has a connection to gold. The paper dollar, despite what Hicks said, would never have come onto the market or arisen spontaneously on the market.

40:18Or even, it couldn't be forced into existence by governments either, because people would not know what the value of the paper dollar was. The paper dollar had to have some connection to a commodity that had a pre-existing purchasing power. In this case, it was the gold dollar. So if you want to use these terms, which was an attempt to belittle Mises' explanation, it's certainly true. It is the ghost or the shadow of gold, in some sense. That's not to say that the dollar itself isn't a real money today, even though it is a pure fiat currency. It certainly is. So those are some of Mises' most important concepts in monetary theory. I want to mention a few others.

41:07and a few others. One, he did criticize the idea that you could average up the value of money into one single unitary figure. That is, that you could figure out a single price level. As Mises points out, the purchasing power of money consists of an array of different specific quantities of individual goods that the monetary unit will exchange for at any point in time. For example, right now, the purchasing power of money is, let's say, one Coke, because, let's say, a Coke is a dollar, or one-third of a Wendy's hamburger, okay, that's three dollars, or, as I found out yesterday, when my wife called me and told me that a Rolling Stones concert ticket was $175, one one-hundred and seventy-fifth of a Rolling Stones concert ticket, or one-sixty-thousandth of a Cadillac escalate, and so on.

42:07So there's almost an infinite array that constitutes the purchasing power of money. And since those are all heterogeneous goods, you cannot add up and average out that array into a single price index, as all modern economists attempt to do, which really was a method of approach that began with Fisher. And I won't go into details, but Mises has some very interesting critiques or very, very interesting criticisms of Fisher's concept, okay? What I do want to point out is that Mises makes a very interesting comment in Human Action.

42:52Mises pointed out that there are many different ways, they're all arbitrary, and we see how the Fed is continually changing the consumer price index to make inflation look less bad. And Mises pointed out the following. A judicious housewife knows much more about price changes as far as that she has little use for computations disregarding changes both in quality and in the amount of goods which she is able or permitted to buy at the prices entering into the computation. If she measures the changes for personal appreciation by taking prices of only two or three commodities as a yardstick, she is no less scientific and no more arbitrary than the sophisticated mathematicians in choosing their methods for manipulating the data of the market. And we saw back in the mid-90s, they took out the price of houses and they put in rents because of the housing bubble.

43:41Price of housing was rising at a much higher level because of low interest rates or a much higher rate than rents were. So it made the consumer price index look better from the point of view of inflation and also the problem of quality changes. I mean, in order for these statistics, these price indices to have meaning, they have to have the same goods. But we know goods are always changing in quality and new goods are always coming into the basket. So, before they changed the basket to include cell phones, I don't know if they did or not, you didn't have cell phones in the basket. You had a huge part of the money, or a large amount of money that was spent on so-called average consumer basket of goods, was spent on cell phones, but that had a zero weight in the basket.

44:32So, what Mises is saying is that there's no scientific way of measuring inflation. of Inflation. Historically, statistics are interesting, they can show us the magnitude of inflation, but a housewife or someone who goes shopping regularly and habitually buys certain goods, on her own can figure out, more relevantly to herself certainly, what inflation is, how bad inflation is. Murray Rothbard was always saying that he hated the CPI because it didn't give a good big weight to books and he was always buying books, the price of books were going up at a very rapid rate, they still are, well you can tell if you're a student, you can see the way textbooks have increased, and being a parent of a student, tuition is weighted, to me it has a huge weight in my budget right now, and that's going up more rapidly. Finally about Mises, pointed out that the quantity theory was wrong because it implied that a given change, a percentage change in the quantity of money resulted in all other things equal a given percentage change in prices.

45:46So if the money supply went up by 10%, prices would go up by 10%. Mises pointed out that this was not correct, that in fact, you had to analyze changes in the purchasing power of money through what he called a step-by-step process, which was later called period analysis. And basically what that was, was the following. You focus on where the new money comes into the system, where it's injected into the system. The government spends new money on weapons guidance systems, they buy more defense computers from Silicon Valley, they therefore create new money to make these purchases. Now what happens? Well initially the people who get the new money, the first people to receive that money are the stockholders and workers in high tech firms, in a specific point, in California.

46:38Now, let's say the workers increase their demand for beer because they have higher cash balances now. They have more money than they want to hold. Prices haven't gone up yet. They don't go up instantaneously and proportionally. Now, the price of beer goes up. The stockholders in these companies increase their demand for fine wines from Napa Valley. So, the price of wine goes up. You and I, or the people who are on the East Coast, we're paying higher prices for beer and wine, Yet, our incomes haven't changed. So, there is a step-by-step redistribution of wealth away from people who receive the new money late or not at all, to the people, including the government, who create and receive the new money initially. Now, let's take a few steps further.

47:24The people in the Napa Valley where wine is produced, the people in Milwaukee who are producing beer, They're much more prosperous. They have higher cash balances. Their marginal utility of money drops because now money has a lower value to them because they have more of it, vis-à-vis other goods. So they spend, let's say, more money on going out for steak dinners. So now the demand for beef goes up. Now I'm paying higher prices not only for beer and wine, but for steak. And let's assume also that they begin buying more automobiles from Detroit. So now the prices of American cars are going up.

48:10So now what has happened? There are four prices that have risen and people who are not yet part of this chain of spending of the new money have their real incomes shrinking. And eventually, maybe 12 months down the line, 18 months down the line, that new money will be spent in New York, where I work. So maybe eventually people will start taking, because they have more money, more vacations in New York. The prices of, let's say, hotels in New York haven't risen, the prices of Broadway shows haven't risen yet. They'll also start taking more advantage of financial services, which are produced in New York. are produced in New York. Now, finally, 18 months later, the demand for a PACE MBA, PACE University MBA goes up, I teach the MBA program. So the price of, so finally PACE's tuition goes up and I get a raise. So for 18 months, what has happened to my real income? It shrunk.

49:11Not only that, the second point that Mises made is that there is a permanent redistribution In other words, the people that gain, the people that are the early receivers of the new money, demand different things than the people that are the late receivers of the money or people of fixed income. So because income has been redistributed and wealth has been redistributed to them, the structure of demand in the economy changes. So let's say retired people on fixed incomes in Florida find that their wealth is permanently reduced and their incomes are permanently reduced. They never get any of that new money. So what you'll see then is, is possibly condominiums in Florida actually falling in price. Even though there's a general inflation in the economy. Because people are demanding, the people that demand those things have suffered a loss in real income.

50:05And as Mises points out, money therefore is non-neutral. That is, increasing the money supply will not increase all prices proportionately and instantaneously. It takes time for the purchasing power of money to adjust to a change in the money supply, number one. And number two, when it does adjust, it adjusts unevenly. So at the end of the whole process, certain prices will have risen by, let's say, 15%, other prices may have risen only by 3% and some prices may have actually fallen. With the implication that resources then will move into those areas that have higher prices and higher profits and away from areas in which profits did not increase or actually fell or where there were losses.

50:59So there will be a readjustment of real resources as a result of the change in the money supply. And if this wasn't the case, Mises points out, then why would anybody inflate? Why would a government ever inflate if as soon as you created new money, all prices went up proportionally? There will be no reason for inflation. It's precisely because money is non-neutral that governments are lured to inflate the money supply, or their central banks. Now, by the way, in current monetary theory, there's a difference made between what happens in the short run and what happens in the long run. In the short run, they admit that money is non-neutral, not in the Austrian sense of percolating or rippling through the economy at a different speed and affecting prices at different times, but in some sort of Keynesian sense. That is, if you increase the money supply, you're going to cause for a while an increase in output and then later on prices will adjust and the output will go back to its natural level.

52:10But in the long run, they still believe, as in the naive quantity theory, that if you increase the money supply by 10%, eventually, in the long run, all other things equal, all prices will eventually rise by 10%, which is crazy. And it was Mises who developed, and Mises alone was responsible for this step-by-step analysis, or sometimes called process analysis or period analysis. And, by the way, no matter how quickly people spend their money, there's still a sequence in which people receive the money. So even if the whole thing happened in a day, it doesn't matter how quickly it happens, whether it happens over 18 months or one day, it still happens in a sequence.

52:55That is, some people get the money first, spend it before prices have risen, they gain. The people who get the money at the end of the day, after most prices have risen, and most of the money has been spent, are the ones that suffer. Because there's been some criticisms of Austrian economic, of Mises' analysis to the effect that, well, in today's world where, you know, money can be spent instantaneously, you know, you can spend on the internet and so on, Well, all prices go up very rapidly, even if they do all go up very rapidly. They still go up one after the other. It's still a step-by-step process and that's important. Okay, let's talk a little bit about Rothbard now and his contributions to Austrian monetary theory.

53:41He developed the theory of how fiat money comes about. What is government done to our money? What he did was to develop what I might call a historical logical theory of how fiat money developed. He bases himself basically on Mises regression theorem. He points out that, yes, fiat money cannot develop by some king simply putting his picture on a piece of paper and calls it one-knit, and then disperses it among the public and says, okay, you have a monetary economy now, go forth and spend and make everybody prosperous.

54:40People wouldn't know how much to charge for the goods they're selling because it has no pre-existing purchasing power. Nor could it be a social compact. In other words, for a while, the general media of exchange in colonial Virginia were tobacco leaves. Well, the people get together and say, let's have a town meeting. We have these problems with barter, including the lack of coincidence of wants. So let's all agree to accept tobacco leaves. It didn't happen that way either. It happened over the course of centuries that gold and silver emerged as the general media of exchange. And eventually towards the end of the 18th century, gold became, the 19th century, gold became the general medium of exchange. The government may have had something to do with driving Noticing silver out, that still has to be explored.

55:36Now what Rothbard did was to look back in history, it was more sociology than specific history. What he said was generally what happened was this. Initially you had a gold standard. The king saw that one way of increasing his revenues was to monopolize the mint so he took over the function of minting money. He took that function over and he charged a monopoly price, but that's called seigneurage. That's a monopoly price for the minting of money. It comes from the French, it comes from seigneur, it's the prerogative of the Lord to print money.

56:25The story is that Signorage initially, during the feudal era, referred to the fact that the Lord of the Manor had the right to spend the first evening with the new bride of his serf or vassal. He didn't actually do that. He would allow the vassal to buy his way out with a certain sum of money. So, in some sense, when government inflates, we get the same thing being done to us. I won't get any more explicit than that. Then, what the king did, since he was vain, he substituted a name for the standard weight of gold.

57:11Gold and silver would initially money circulated simply by weight and not by tail. Tail being the name. So you substituted a brand name, then as banks emerged, people began to accept banknotes, as we talked about, and checking account deposits, denominated in the name, so now you had dollars, or francs, or pounds, even though they still referred to and were defined at a specific weight of gold, The dollar was defined from 1834 to 1933 as about one-twentieth of an ounce of gold. The pound was defined as about one-fourth of an ounce of gold from 1821 to 1931.

58:00But now people see this paper money that's circulating and that has its name on it. Now, since these banks or fractional reserve banks, as fractional reserve banks grow up, They get into trouble at various times in history. They ask the government to bail them out. The government then legally permits them to suspend payment of gold in exchange for the paper money. And so people continue to use the paper money. It now becomes what? We have a progression, or I would call it not a progression, but a devolution away from gold or commodity money towards credit money. But now people become used to the fact that it's the paper that's the money.

58:45Now eventually they go back onto the gold standard after the war or after the bank crisis is over. But now people have in their minds that the dollar is the actual piece of paper that they're holding and the gold somehow is backing it up. Governments encourage this by setting up a central bank which issues its own paper money. The Bank of England issued its own paper money, which is backed up by gold, and it's defined as a weight of gold, but now they even have more confidence in banks, because look, we have the full faith and credit of the British government behind these notes. So that causes people to further, it furthers their belief that it's the paper that's the actual money.

59:32And the commercial banks begin holding the central bank notes, which themselves are convertible into gold, but they begin holding those notes as reserves. So, when you cash a check, you don't get the gold, you get the paper pound notes issued by the Bank of England, which does promise to convert that into a fourth of an ounce of gold, approximately, for every one pound note. Going further, Rothbard points out that then governments begin implementing a gold bullion standard, meaning that, well, before that, they begin to centralize the gold reserves. They tell the banks, look, give us all the gold, we'll keep them in our vaults, you just keep our paper notes.

1:00:20So they centralize the gold reserves. Then they begin to convert their notes into only gold bullion, big bars of gold. And they encourage people to use their notes or checking accounts at the commercial banks for everyday transactions. So the circulation of gold coins diminishes. And you just see paper money. So now the gold coin is all locked up in the vaults and for the most part it's people, big businesses involved in international trade that will convert the notes into big bars of gold bullion that are not convenient for everyday transactions but they are convenient for shipping back and forth for purposes of settling international trade balances.

1:01:11Then the government, after bank failures, come up with a deposit insurance. So now people know that, look, that dollar is as good as an ounce of gold. Finally, governments during the war go off the gold standard. So during the Civil War, the U.S. goes off the gold standard. During the Napoleonic Wars, as I said, the British Bank of England goes off the gold standard. Again, people don't like this, but they believe that they're going to go back to the gold standard after the emergency passes, after the war is over. So finally, World War II comes along, World War I, all belligerents went off the gold standard, including the U.S. when it entered the war.

1:02:03So people are now very, very used to, in the 1920s, 1930s, they're used to money as paper money. They still have faith in it because it's backed by gold, because they believe that this gold is all in a vault, somewhere in the central bank and the government's guarding it rigorously. Okay, so what finally happens then? What happens in World War II? We go off the gold standard, Britain goes off the gold standard in 1931, we go off in 1933, France goes off in 1936, and the war ends, people still have expectations, even Mises had expectations, right? That we would go back onto the gold standard.

1:02:48What they do is they set up a phony gold standard, okay? A gold standard in which, as it was hammered out at Bretton Woods by the various allied powers, Great Britain, the U.S., France, and so on. Under this Bretton Woods system, only the U.S. dollar was convertible into gold at the rate of $35 per ounce. So that's the other point. They also devalue, so even though gold was defined for about a hundred years or the dollar was defined for about a hundred years as one-twentieth of an ounce of gold, in 1933 it's devalued and made less than one-thirtieth of an ounce of gold. In other words, the price of gold has changed. So you act as if it's the paper that's the money and that you're changing the price of the gold, which is sort of just what backs up the money. It's not the true money itself.

1:03:39So, as you devalue, people begin looking, the paper dollar contains less and less gold, let's say, or the paper pound contains less and less gold, okay? So, that's something else that acclimates people to thinking of paper money as the actual money and not just as simply the receipt for gold, okay? Which, in fact, is what it was under a commodity standard. So the phony gold standard is set up, as Rothbard points out, dollars convertible into gold, but not to U.S. citizens. U.S. citizens aren't even allowed to own gold from 1933 to 1976, let alone convert their dollars into gold. Only foreign governmental institutions, foreign treasuries, or foreign central banks can convert dollars into gold.

1:04:27So by the mid-60s, the U.S. is inflating like mad because foreign governments have backed their currencies by the dollar because the dollar is as good as gold. The U.S. government has solemnly promised in 1946 to convert all dollars held by foreign governments into gold. Now, that was back when the U.S. government had most of the gold in the world. We had a stockpile of gold of over $25 billion worth at the rate of $35 per ounce. There was something like maybe $12 billion held by foreign governments. So the foreign dollars were more than 100% backed up by gold, so everyone trusted that the U.S. government could pay off. But in the 1960s, as President Johnson promises us guns and butter, that is that we're going to fight the Vietnam War and increase spending on the Vietnam War.

1:05:22We're also going to fight the war on poverty. We're going to increase the welfare state. And we're not going to raise taxes. We're not going to prevent people from purchasing consumer goods. Well, how does he pay for all this? He prints new money. And he prints tremendous amounts of money. So tremendous amounts of money are printed during the 1960s. Eventually, our gold stock falls to $12 billion. Foreign dollar holdings go up to $80 billion. The French start to get nervous. Germans get nervous. Germany is basically an occupied country. There are still American troops there, so they can't make too much noise. The French pull out of NATO. They form their own nuclear force, independent of NATO, so that the U.S. can't blackmail them, because the U.S. was saying, well, we'll pay your dollar liabilities in gold, but we're going to have to remove our nuclear umbrella.

1:06:12And it was Mises' follower and friend Jacques Rouef who pushed the goal to force the U.S. to convert dollars into gold, which was a great thing. The U.S. really couldn't do it. 1968, there's still free gold markets in London and Zurich. Price of gold is shooting up above $35. So how do you keep the price of gold back down to $35? The U.S. has to continually pour gold into these foreign markets. So in these foreign markets, you have a run on gold. So now our stock falls to $9 billion. And there's a run on gold in 1968. They stopped the run by saying gold will only be traded between central banks.

1:07:01From now on, we're not going to worry about the free gold market, which means that then the price of gold, there's two prices of gold, the price of gold goes up because of the inflation of the dollar. 1971, foreign governments want their gold back. So there is such a run on gold that U.S. gold stock would have completely run out within two weeks. President Nixon then reneges on the solemn pledge to continue to convert dollars into gold in 1971. He closes the gold window, as it is said. At that point, as Rothbard points out, the last link to gold is broken. The last tiny link to gold is broken, and you have fiat money. So, because Rothbard was such a good historian, he was able to come up with an historical, logical explanation of fiat money.

1:07:52So, fiat money has to develop from commodity money. So, if you want to use Hicks' sarcastic reference to Mises regression theorem, that the dollar or the pound is the ghost of gold, well, in some sense it is. and Rothbard rigorously has shown how you can get to fiat money from commodity money. This is a great accomplishment of his. Another great accomplishment of his was that his definition of the money supply. He found an article by a Chinese economist written in the early 1930s and neglected. The name of the author was Lin Lin, and I can't remember the exact title of the article.

1:08:40But that sparked in Rothbard the thought that the medium of exchange can be defined as anything that people will routinely and universally accept as a final means of payment or anything that is immediately interchangeable into the medium of exchange, that is dollars, at par, on demand. Well, I've been redundant there. Anything that's redeemable in cash, instantaneously, and at par. Now, that's certainly true of checking accounts. You can instantaneously redeem your checking account deposits by writing a check to a third party, or by going down yourself and cashing a check and withdrawing the money from your checking account.

1:09:33But Rothbard pointed out, and this is Lin's point, The same was true of savings accounts. You could immediately transfer them into, especially with ATM machines today, savings accounts can be transferred into checking accounts. Or you can immediately withdraw the money, especially with ATM machines, you don't even have to walk to the bank from your savings account. So Rothbard said, since savings accounts are functionally identical with checking accounts and are in fact immediately interchangeable with the checking accounts, is ordered to cash on demand at par, at par meaning that for every dollar that you have on the books in your checking account, you can get a full dollar out. So Rothbard, in his book, first develops this definition of the money supply in America's Great Depression, and then writes an article in 1976 defending it on the Austrian definition of the money supply in 1976.

1:10:38So Rothbard then actually goes further and he points out not only are savings accounts immediately and instantaneously redeemable in readily spendable dollars, But so are savings bonds. You know those bonds you were given when you were younger that were issued by the Treasury? They're government savings bonds. Well, basically they're claims, immediately redeemable claims against the Treasury. After six months, even though they have a nine-year maturity, after six months you can redeem them without losing any interest, with interest, at any bank or at the Treasury. So even though their formal maturity was nine years or seven years, I don't remember what it was, you paid $50 and you got a $25 bond. You got the accrued interest, we're giving them before maturity, so the stock of savings bonds was included.

1:11:29He also included two items that used to be in the money supply but were dropped out after World War II for some reason. Government deposits, in other words government deposits that governments held at commercial banks and that the US government held at commercial banks and at the Fed. Now they're not included in the money supply. But Rothbard pointed out that they're no different than any other demand deposit. They can be spent at any time by the government, so that was included. Any included, which again was dropped out, foreign government deposits held at US banks. All deposits held by foreign governments and foreign central banks and US banks. So he took Mises' definition of money to its logical conclusion.

1:12:17The money supply consists of the general medium of exchange. And the general medium of exchange is any asset that can be readily spent or that is immediately redeemable at par into an asset that can be readily spent. So this was a great advance in theory of the money supply.

1:12:46There's a few other things that he added to monetary theory. His theory of the demand for money, I just might mention that last. In it, what Rothbard did was to show that there was really two components to the demand for money. And he took the following. He said, look, the overall demand for money is equal to what he called the exchange demand for money plus the reservation demand for money. Okay. So there's two ways of demanding money according to Rothbard. The first is the exchange demand for money. Anytime you sell anything, you are demanding money. So when you go to work, you are selling your labor services in exchange for money.

1:13:34That's a representation or that's an instance of the exchange demand for money. So we're always looking, when you talk about the market for money, we're looking at it from reversing things. You are buying money. When you buy apples, you demand apples. Going out and purchasing apples or steak or something is a reflection of your demand for that thing. The same thing is true with buying money. When you work or if you sell your used car to someone, you are selling something in exchange for money. You are demanding money. That's the exchange demand. The main part of the exchange demand for money comes from the supply of goods and services every year in the U.S. economy. So, as the economy becomes more productive, as we have so-called economic growth, you want to use that biological metaphor, which is really not a good metaphor, you have an increase in the exchange demand for money.

1:14:31As population increases and more people go to work, the demand for money is increasing. People demand more money. Now, this is also called the pre-income demand for money. So, what happens is that when your demand is exercised through going to work, now you've gotten your paycheck, do you hold all that money? Do you keep it and just keep piling it up? No. You take some of it and you spend it on goods and services, depending on the marginal utility of money versus other goods and services. But you do hold some in your checking accounts. You don't spend all the money that you get when you exchange other goods and services for it. You don't immediately spend all your money. You hold some.

1:15:21Right now, all of us are exercising a reservation demand for money. Right now, by not rushing out and purchasing various items, we are holding in our wallets and our checking accounts a certain sum of money, each one of us. That constitutes a reservation demand for money. So, during any period of time, the demand for money consists of, and for the fellows here, I'm going to give a presentation presenting a paper I'm working on, going further into detail about this. But the demand for money during any, let's say, week, refers to the following. The amount of money that people receive for selling things, which is simply the amount of money that's spent on goods and services, but we're looking at it from the other side, plus the amount of money that is held off the market by people in their pockets.

1:16:22So, for example, if there's $1,000, if we're a small community and in total, let's say we have in total $10,000, And we purchase, at market clearing prices, $7,000 worth of goods and services, including labor services, okay? So people sell $7,000 worth of goods, they have exercised an exchange amount for money and receive $7,000. But if $7,000 was spent, the other $3,000 was held in people's cash balances. Why do people do that? Well, for spending in the future, for medical emergencies, for opportunities for good sales, or investments that they may find.

1:17:10So, there's both an exchange demand and a reservation demand for money. That's an important Rothbardian innovation. And one thing that it leads to, by the way, is to realize that the natural tendency of prices in the free market economy is to fall. Because, in a free market economy where you have a commodity money, which tends to be naturally scarce and therefore to increase at a very slow rate over time, where you have capital accumulation, the exchange demand for money increases tremendously. So, if the supply of gold is fixed or increasing very slowly, and the demand for money is increasing because of the increase in supplies of goods and services, You're going to get a naturally falling price level, which is what we had during World War II.

1:17:58I'm sorry, it was what we had during the 19th century. Prices in 1896 were as low as they were in 1812, or maybe even a little bit lower. Then there was new discoveries of gold, and prices rose from 1896 to 1913. And people call that the great inflation. Prices rose by 13% from 1896 to 1913. That's not 13% per year, but less than 1% per year, and people thought, oh, this is a great inflation. Imagine that. But by 1913, prices were then maybe just as high as they were in 1812 or something. So, the natural tendency is, as we see in those high tech industries in which we've had tremendous technological improvement, for prices to fall.

1:18:46Despite the fact that the Fed has been inflating like mad during the late 1980s and 1990s in terms of increasing the money supply, the prices of computers have come down tremendously because technological progress and capital investment in the computer industry has been so great that the exchange demand for money on the part of people in that industry has increased more than the supply of money. And if you think about it, if you go back to 19, you know, right before World War II, a model T Ford cost you about $350, a men's suit was something like $20, an ounce of gold was $20.

1:19:36Well, if you look at things today, in terms of paper money, a middle class automobile is $20,000, let's say. A good man's suit or a decent man's suit is between $300 and $400. Basically, what's happened? A man's suit is still one ounce of gold, at the current price of gold. So, paper money has depreciated. So, what would have happened is that we would have had to fall on all prices. If the government hadn't, the money supply stood at something like 25 billion dollars in 19, right before the Fed came into existence in 1914. I think it was 25 billion. In any case, what does it say? M1, which is a narrow definition, Austrians would have a broad, but let's just take M1.

1:20:25M1 is one trillion dollars. So the government has increased the money supply many, many times over, and that's what has prevented a fall in prices. We would have had extremely low prices in dollars if the government, if the Fed hadn't come into existence and inflated the money supply. Alright, I will stop here and take about six minutes of questions or so. Yes? At the end of World War II, we were using cigarettes, and I remember it cost me three cigarettes to have my laundry done. Was this, I know in POW camps, in German POW camps, American soldiers used cigarettes. Are you speaking about that, or are you speaking about actually in the Army?

1:21:11In the Army. In the Army, yeah. When the war ended, I lost my laundry. Cigarettes were something that everyone routinely accepted, most people used, and therefore they became, there's a famous article by an economist who was a German POW who came out in 1946 in which he showed how cigarettes grew up as the commodity money in these camps because care packages were sent every month and cigarettes were part of these care packages and most soldiers, in every World War II movie everybody's smoking of course, So what people did then was, since the care packages were standard, yet people's preferences differ, because people have different subjective values, what people did was, in exchanging for goods that they preferred more and giving away goods that they preferred less, they would exchange the goods that they didn't want for the cigarettes and they'd go and find the goods that they did want.

1:22:07And they'd suppose prices at the end of each barracks. Not only that, as people smoke the cigarettes, towards the end of the month, there was deflation. And when a new care package came in, the prices all jumped up. I was given a carton of cigarettes every month. I didn't smoke them. So you traded them. Right, right. Yes. I noticed the media always refer to rising prices as increasing inflation, and I'm confused by that because I always thought there was a distinction between rising prices and rising inflation.

1:22:53As the term inflation is used today, that's true. Inflation is a rise in the price level. If the inflation rate goes up, then they should say it's an increase in the inflation rate. In other words, if prices start rising at 5% per year instead of 3% per year this month, that is, it's calculated. Let's say every quarter they tell us what the consumer price index is, or maybe it's every month. In any case, an increase in inflation means that prices are rising at a more rapid rate, or it should mean that. Well, if not, doesn't that mean that the money supply is increasing? It has nothing to do with prices. I think it's kind of on the ten-hole side of things that we've done.

1:23:38But rising prices cause inflation, like white streets or the ranch.

1:23:58So, I guess your question then is different. What you want to do is you want to go back to the earlier definition of inflation as a change in the money supply. But remember, definitions are arbitrary in science and we define things in a way so that they are expedient. And so they allow us to clearly get our concepts across to one another as economists and to the public. and you are absolutely right. Defining inflation as rising prices hides a lot of things. So in the 1990s it looked like we had very little inflation because prices weren't rising much. So no one expected the bubble and the recession that we got in 2000-2001 because there wasn't much consumer price inflation.

1:24:51But in fact, if you look at the money supply figures, as Austrians did, you saw that, in fact, there was no money being injected into the economy, and it was affecting certain sectors of the economy. Not the CPI, which everyone looks at, but it was affecting the housing market, it was affecting the financial markets, the financial market bubble burst, bringing in its train a recession. So the Austrians were predicting some sort of a recession in the 1990s, because they were looking at the money supply. And it would be better, and George Reisman argues this and I agree with him, it would be better if we went back to defining inflation as changes in the money supply because changes in the money supply have many different effects beyond just a rise in consumer prices. It pushes down interest rates, it pushes up asset prices, it pushes up housing prices, it redistributes income and so on.

1:25:43But all of that is hidden when you just focus on one effect of an increase in the money supply and call that inflation. If you go and find an old Webster's Dictionary that is 40 years old, the definition of inflation in it is an increase in the amount of money.

1:26:18can move up or down. The money supply is a volume that increases, so in some etymological sense, it's more intuitive to think of inflation as a change in the money supply. Can you talk about the relationship between the commodity value of money necessarily that stems from gold, futures, and demand itself, and then the desire for people to have a low transaction cost, especially with internet commerce right now, and international commerce and the ease and velocity of money.

1:27:03would use predominantly digital credit rather than necessarily cash, or for security purposes, given a gold standard system and an accumulation of gold being used in reserves necessarily, but if you rarely see the redemption taking place, how does that affect necessarily with the relationship of a separate market for people who use gold? There will still be a need for cash transactions, for physical cash transactions. And Mises always stressed that we should have gold coins in circulation. But one of the problems is, and we'll talk about this on Friday, gold is so valuable now that it would be extremely hard to have gold coins for small transactions.

1:28:00And so, Guido Hussmann has argued that a silver standard also would be reinstated and may be the primary cash in the system. Certainly, though, any transaction over the internet and so on using claims against gold dollars, let's say, would still be based on a commodity. No one's going to accept something that has no pre-existing purchasing power. And that's why it's difficult to simply, for example, some people say, well, let's just allow people to make contracts in gold, and then when the government inflates the money supply, people will shift to gold because its purchasing power is more stable and use that as a money.

1:28:51But all of us think in terms of dollars, and all of us do our calculations in terms of dollars. So the inflation would have to almost be a hyperinflation and destroy the dollar itself, which we don't want, before I think Americans would go back spontaneously to a gold standard. That's why Rothbard has always, and we'll talk about this on Friday too, has always emphasized that it's important that we at least initially relink the dollar to gold. Give the American people the gold that was stolen from them in 1933 and put in Fort Knox. Most of it is in the New York Federal Reserve Bank now. But anyway, get gold back in circulation. Then if we need silver to supplement it, it will be monetized by the market.

1:29:36I have to stop here, but that's a very interesting point. We're going to talk more about it on Friday. Okay, thanks.