Dr Joseph Salerno, Academic VP of Mises Institute joins me in this episode to talk about his views on Bitcoin, monetary velocity, how money emerges on the market and more.
Joseph Salerno links:
Sponsor links:
- Swan Bitcoin
- Unchained Capital
- New Brighton Capital code: LIVERA
Relevant prior episodes:
- SLP51 Dr Guido Hülsmann – Austrian Monetary Economics & Bitcoin
- SLP45 Jeff Deist, President of the Mises Institute
- SLP169 Jeff Deist – Bitcoin & Acting Locally
Stephan Livera links:
- Show notes and website
- Subscribe on YouTube: @stephanlivera
- Follow me on twitter @stephanlivera
- Subscribe to the podcast
Podcast Transcript:
Stephan Livera:
So I’m just going to introduce Dr. Salerno. Dr. Salerno received his PhD in economics from Rutgers University. He is a professor emeritus of economics at Pace University in New York City. He’s the editor of the quarterly journal of Austrian economics and the academic vice president of the Ludwig von Mises Institute. I’m a big fan. I’m a huge fan of his book, money sound and unsound. And I’m very pleased to invite Dr. Salerno. Welcome.
Joseph Salerno:
I’m happy to be here.
Stephan Livera:
Dr. Salerno, this is a Bitcoin focused podcast, although obviously I’ve got a big on big fan of Austrian economics. I’d love to just start talking a little bit about Bitcoin and understand a little bit of your thoughts around what it takes to, you know, for something to emerge as a money. So perhaps we could just start by chatting a little bit about I know you’ve read my friend Saifedean Ammous he’s a regular guest on the show, and I know you, you had the opportunity to read The Bitcoin Standard. I’m wondering what were your thoughts on that book?
Joseph Salerno:
I thought it was a very good book. He explains the emergence of Bitcoin in accordance with the way Carl Menger, the Austrian school economist who founded Austrian economics the way he explained the origination of money. So I’m quite fond of the book. There’s probably nothing I really disagree with in it.
Stephan Livera:
Well, it’s very impressive. And I would love to chat with you a little bit. Obviously I’m a student of Austrian economics myself, and I think there are different ways people might conceive of how money starts, right. And so the inaudible story is, you know, the most saleable commodity, if you look at someone like say David Graeber but he might say, Oh money first emerges as debt. Right. And and then there are others like say someone like say Nick Szabo, who might have a slight twist on the Mengerian story where he might see it. Like it doesn’t have to necessarily be like transactional back and forward use, but it could be things like it could start as something like a medium of wealth transfer that people would you know, for like transferring a dowry or an inheritance and people might’ve used gold in those kinds of scenarios before using it in like a day to day transactional use. So I’m curious, Dr. Salerno. What’s your view there on this idea that it could start in a more let’s call it high value transfer before moving to kind of buying bread and coffee and so on.
Joseph Salerno:
I can see how it could be used in dowries or other as you said, high value transfers. Initially, but that doesn’t explain how it gets into circulation because people don’t know what its purchasing power is. I mean, the price of money are the alternative amounts of goods and services that can be purchased with that. So it can’t just go from being an occasional transfer for ritualistic or matrimonial purposes. There has to be some kind of initial origination in trading that particular good, whatever it may be for other goods for direct use value.
Stephan Livera:
Fantastic. And I think this comes into the Mises regression theorem as well of saying it has to first start with a certain use. And then beyond that, then people can start using it more as a, as a way to transact. I’m curious as well, when people talk about, say with gold to say, okay, there’s like an industrial use to gold, but then there’s maybe arguably also a monetary use to gold. Would you, would you agree with that sort of framing that it, that it might initially start with an industrial use and then later become more like a monetary use?
Joseph Salerno:
Yeah, sure. I mean, a gold was used for a ritualistic purpose of religious purposes to as conspicuous consumption people, the rich or the Nobles embroidered their clothing with gold as a symbol of status. But, but in doing that, it attained the value to these people and they could compare it to the value of other things that they could get in exchange for gold and so money or at least gold as a good, that could be transferred, exchanged began in that way. And it was only after awhile that that people began to see certain qualities in gold permitted it, or to be used to to purchase other goods. So if you, if you produce something very specialized Bob Murphy uses the example of a telescope or something that very few people would want. One of the things you would do is to first exchange for something like gold or wheat or something that is that’s generally accepted.
Stephan Livera:
Excellent. And so they it, so essentially people are looking for that thing. That’s more easy, more saleable, right. To use the Mengerian framing, right? And so I’m curious as well to get your thoughts on what components make up the most important. What’s the most important thing inside that saleableness kind of category, if you will. And I think tying this back to say Saifedean and his book, The Bitcoin Standard, and some people, even in the gold world, they would blog and talk about this concept of stock to flow. Right. And so I guess that is getting at this idea of scarcity. So in your mind, how important is the scarcity factor versus say some other factors, like say divisibility or ease of use things like that?
Joseph Salerno:
Well, I think the scarcity factor is extremely important in the following sense, I mean take iron, which is very durable, it’s homogeneous. And, but yet it lost out as, as one of the the media of exchange. It probably was used, it was used in Africa for awhile, but it’s basically the portability the value to weight ratio that has to be very high and for, so in order for that to be high, then we get into the scarcity issue. Gold has to be a very scarce or any medium of exchange needs to be very scarce, which then in itself implies that the flow to stock ratio tends to be very low. And we know with experiences in the 19th century, for example, that a great gold inflation would be one in which, you know, prices rose 1% per year between 1896 and 1913, there was, I think 13% increase in prices over those years. So less than 1%, but people considered that a great inflation. And that goes back to this important characteristic of a very high stock to flow ratio or to reverse it low flow to stock ratio.
Stephan Livera:
Right. And I think another really interesting point that you were touching on there is around when it comes to the production of money. And we could call this the markets, the response to the social demand for money. And I guess historically if there was a lot more demand for money, then that would have triggered off a lot more people to go and become gold miners and then go, and actually mine more supply. But it just so happened to be that gold was, I guess, the hardest thing from a stock to flow ratio, point of view. Would you agree with that kind of idea?
Joseph Salerno:
Well yes, in fact, you’re exactly right. When the demand for money went up people wanted to hold more or there was more goods to be exchanged. So they needed more money, or what happened would be that prices would fall and, the prices of everything, including the prices of the inputs into the, into gold. So that made it more profitable to mine gold. So even though in a year or two, you didn’t get back to the old price level. It took a number of years after a while. Prices returned to the, for example, from, you know, early 1880’s – 1896 prices returned to what they were in 1896 they weren’t the same as they were in the 1880s because of the spur to gold mining.
Stephan Livera:
Fantastic. And so with the way people interacted under a gold standard now, obviously we’ve had different types of gold standards. Historically, I think from what I’ve read, it seems like the classical gold standard was kind of a less government intervention version. But then later we had greater government intervention into the market for money, and that’s where the government puts in controls or tries to set the price. And so on under that environment where it’s less government influenced, would we say essentially that the market has less because there’s less credit expansion and that therefore we would say there’s less distortion by the government because essentially the supply is really being driven by what the market demands, as opposed to, you know what happens when the government expands or permits credit expansion?
Joseph Salerno:
Yeah. So up until 1914, which was really the death of the classical gold standard is World War II. Most countries within two weeks of the outbreak of the war went off the gold standard. And the reason they went off the gold standards, because the gold because the gold standard did restrain the government’s ability to increase the money supply and pay for the war rather than paying for the war through raising taxes. So once that happened, that you no longer had the market completely in control. So once then the Fed in the United States, we did not have a central formal central bank until 1914, when a federal reserve system came into existence, after the fed came into existence, it was able to centralize all the gold reserves at the Fed by 1917. And it had the ability to manipulate the discount rate, which was lowering the rate to increase the borrowing from the banks.
Joseph Salerno:
And then in 1920s, it discovered that, Hey, I can create paper dollars out of thin air and buy up government bonds and increase the money supply further. So gold was still there at the base of the system, but that the inverted triangle, which we had layered bank paper money from the fed on it, and then the checking accounts of the, of the banks themselves that pyramid expanded and that, so that was enough to drive the inflation of the 1920s. So even though prices were pretty stable in the twenties, we had a tremendous boom in real output, in technology and saving. We had refrigeration coming in, the radio, mass production of cars, prices should have fallen, but because of the massive credit expansion price is pretty much stayed the same, which meant that the money supply was increasing. If you look at it by 6% or 7% per. And so we did certainly we didn’t get price inflation, but we did get asset bubbles in real estate, in the United States and in the stock market. So I was going to say we had a very watered down gold standard by that time it was known as a gold exchange standard.
Stephan Livera:
Yup. And so I’m curious as to, in your studies and research of that time prior the government, like more government intervention into it, would it be fair to say loans were harder to come by at that time? And that it might’ve been like interest rates were higher?
Joseph Salerno:
During what period of time?
Stephan Livera:
So in, during the classical gold standard era before kind of the massive expansion of credit, would it be fair to say that, or would you say kind of interest rates could still be low even in that prior era?
Joseph Salerno:
Yeah. To the extent that interest rates were low in that era, they were low because people trusted the value of the money and were willing to save. And with the increased savings there was increased lending. And, so you had naturally low interest rates that is interest rates were such that they equilibrated or balanced the amount of saving with the amount of investment that that business firms wanted to do. That link was broken once the government began manipulating interest rates, we then got this credit expansion, which went the loans, as you said, were less restricted because they went beyond the voluntary saving that people were doing.
Stephan Livera:
Yeah. Right. And so I guess for listeners, it, you might think of it, like you can have a natural market driven rate for interest, and then it’s almost like the government interventions might artificially suppressed that rate of interest. And so it might to the entrepreneurs out there in the economy, it might look like, Oh, look, there’s lots of resources available, go and borrow and do your investment projects. But the reality is that’s kind of almost like a mirage wouldn’t you say?
Joseph Salerno:
Yeah. It’s absolutely absolutely a mirage because when that new money that is not genuine, savings gets paid out to the workers. The workers don’t save that money. They go back to the consuming as they were before. So they have more money to spend on consumption. They spend the same proportion, but now they have more. And that drives up the prices of consumer goods and withdraws those resources makes them more expensive, drives up wages. And a lot of these projects that were started under the illusion that interest rates were really lower. They become unprofitable.
Stephan Livera:
And I would also like to chat a little bit around this idea of people being able to hold their own money, because I think that’s something special with Bitcoin that, okay. So in the Bitcoin world, when you hold the private keys, so think of that, like the password for your Bitcoins, if you will, that allows you to really treat it like a bearer asset. Like I’m the one holding this. And I think potentially that is something special about Bitcoin that is not available in any other sense. Because I guess with gold, you can physically hold the gold, but then the challenge is if you want to send that internationally or, you know, at long distances, that’s kind of one difficulty. And I think as well, this comes through as a theme in your book as well, is this idea of sound money being free of government interference. So I guess in your mind, when you’re thinking about what makes a good money, does I guess, resistance to centralization or resistance to being stored in, let’s say the vault of Fort Knox and so on, does that play Into your mind in terms of what would make a better money?
Joseph Salerno:
Yeah, sure. What makes a sound money is the money which politicians can’t tamper with. So what that means is that the supply of money is market based. The mining, the minting, the coining and the holding and warehousing and storing of money are all private. I mean that’s the ideal of sound money in which politicians are completely barred from interfering with the supply of money. And so that’s true of gold. That’s also true of an asset like Bitcoin. I don’t think it’s quite a money now, but it’s certainly a payment system and certainly a valuable asset and it’s purely market produced. So it’s an asset that the government has not yet gotten, found a way to control.
Stephan Livera:
Right. And I think the other question that for people who are, maybe they’re a little bit newer to this whole world, and they might see alternative cryptocurrencies and they might think, Oh, but see, that means Bitcoin isn’t scarce because someone can go make some other cryptocurrency. Now, I guess the typical response that we kind of Bitcoin people would say is, well, hold on if you were to try and make some other money, it wouldn’t necessarily have the same network effect, right. There wouldn’t be the same kind of exchanges, merchants who want to take it, the miners and so on. And there’s a kind of network effect around one. So even though from the outside, it might look like, Oh, you can just make your own, there’s a real difference there in terms of who you could trade with. So in your mind, does network effects also play into that idea of what makes a better money?
Joseph Salerno:
Yeah, sure. I mean given the larger the network, all of the things equal the sounder the money will be right there, there’ll be a more stable demand for that money. If someone comes in with a, with a new cryptocurrency and attempts to get people to use it, I mean, the people the initial users are people who are thinking about use are going to find that there, not that many people, other people that accept it. So there’s going to be real disadvantages in establishing an initial network. So you ha you have to come in with something that’s better than Bitcoin, that is better enough that people will abandon Bitcoin despite the disadvantages of not having an established network initially for this other currency.
Stephan Livera:
Yup. Yup. And also when we’re talking about people, having the ability to self custody, Bitcoin or just whatever, whatever it is that you want. Right. I think also part of it is about being able to easily know the full supply. So with things like Bitcoin, if you run the software, you can sort of see, okay, this is the total supply. And that there’s been no inflation beyond the 21 million that everyone is set on as the limit. But I suppose getting into more questions around things like if you’re coming from a full reserve banking view, or you’re in the fractional reserve banking camp. Now personally I’m in the full reserve banking camp. But I guess, is it possible
Stephan Livera:
People use, let’s say IOUs, and then those IOUs start to become treated as though they really were a Bitcoin. And then that becomes a way of supply expansion?
Joseph Salerno:
So the IOUs you’re talking about are IOUs to specific amounts of Bitcoin, right?
Stephan Livera:
Yes.
Joseph Salerno:
I think that that can happen. But I think the fact, and this was brilliant that the founders of Bitcoin established right out of the gate credibility and the limit of supply is something that if you begin to issue IOUs, that credibility will be shaken and there’ll begin to be a shrinkage of the network in some sense, and there’ll be scope for other entrepreneurs step in with other types of cryptocurrencies.
Stephan Livera:
I see. And I suppose now, again, I’m in the full reserve camp, but let’s say, imagine someone was in the fractional reserve camp here and they might think of it like, Oh, but see, you know, we need this kind of banking network to use it, to make it easy for people to do transactional stuff, because maybe Bitcoin is not suited for day to day commerce. If it were significantly adopted that they might sort of argue and say, well, no, we need some kind of fractional reserve system, to permit, or at least it may be a vector by which it gets introduced. Is people using, say a retail banking service or application. And then actually what’s been getting traded around here is IOUs.
Joseph Salerno:
So yeah, yeah, no, I’ve got to ask, but what problems would Bitcoin be facing that will be solved by the IOUs? I mean, Bitcoin is extremely divisible and easily transferable what problems are there maybe that there’s no interest on it? So that is of course the lore to getting people to accept IOUs. You put the, you promise the people that are holding the Bitcoin, that they’ll, if they make the Bitcoin deposits they’ll earn interest so then it becomes an unstable fractional reserve banking system. I don’t see besides offering interest. I don’t see what problems are solved by going to a system where you have fractionally backed Bitcoin IOUs circulating.
Stephan Livera:
Gotcha. And I suppose the other argument around fractional reserve banking is people might say something like, Oh, but without the credit, we wouldn’t be able to go and invest into this business and we’re going to have a significantly reduced business investment and so on. But I suppose that’s ignoring that you really can still have loans in a full reserve banking environment. It just takes place in a different way. Correct?
Joseph Salerno:
Yes, it absolutely does. It takes place through other financial intermediaries, excuse me. Like money market mutual funds, like certificates of deposit that are denominated in Bitcoin, but where you forswear taking the deposit out for 30 days, 60 days or two years that there are, you don’t need fractional reserve banking to get genuine savings into the economy and invested in new and better capital goods and providing economic growth.
Stephan Livera:
Understood. And I suppose just one other angle, so obviously I’m with you there. I guess one other angle, it could happen in a way where it’s unknown to people. So let’s say they think they are transacting with, you know, let’s say I’m using some Bitcoin bank A and you’re using Bitcoin bank B. And, you know, in my app I say, Oh, send Dr. Salerno, you know whatever, a hundred thousand Satoshi so, or whatever. And we think we’re transacting with real Bitcoins, but actually we’re just transacting in IOUs on this layer that has been built up by retail banks. Do you see that as a kind of, Is there, are there any.
Stephan Livera:
Historical parallels there with people in kind of, you know, thinking back to gold and, you know, passing around tickets that represent gold? Are there any parallels there in your mind?
Joseph Salerno:
Well, I mean, there was with the bank of Amsterdam, right? Right. They claimed to be a full reserve bank that, you know, fully backed up their, all their notes with gold and all their deposit accounts with gold. But when the French invaded and took a look at the books of the bank, it turns out that the bank had not honored that promise that solemn contractual promise to maintain a hundred percent reserves. So I guess, given the fact that, you know, these currencies are digital, something like that could develop, but that would undermine, I think once it was found out, it would undermine currency confidence in not just the currency that was doing it, but if there were competing cryptocurrencies, it may undermine confidence in them.
Stephan Livera:
I see. Yeah. So I guess we could say, it depends on what the community of users and people want. And so let’s say the users were using some service and this service is purportedly full reserve, but then later it came out that no really, they weren’t, and only those people who were storing Bitcoin using holding their own keys, running their own Bitcoin software, they were the ones who didn’t lose out in that scenario where the ones who are trusting that service in this hypothetical case, they’re the ones who lose out right?
Joseph Salerno:
Yeah. The ones that trust is a service that, I mean that you know, surreptitiously lends out, in effect lens out the their Bitcoin or issues, more claims to their Bitcoin to people who are paying interest to that particular bank. Yep. Yeah.
Stephan Livera:
I think for some of my listeners, I think I’m probably familiar, but just for some of my listeners, could you explain a little bit around how loans might work in a full reserve scenario and the difference there between let’s say, okay, I guess the example might be something like you’ve got, you know, a hundred pieces of gold and a hundred tickets that represent, you know those gold. And I guess the point you’re getting to there is that if some financial institution issued more tickets than the amount of gold pieces they had, that is credit expansion, right?
Joseph Salerno:
Yes, that’s bank credit expansion. And so that means that the bank can’t simultaneously fulfill all of its contractual obligations to pay out the full amount of the deposits and notes or IOUs that it has issued. And in fact, of course, when you make a deposit and you get a ticket, that ticket is really not to the positive, that is not an IOU. That is a bailment that if you stored your furniture, because you were going on a business trip for two years, you’re going to be in a way. And they rented that furniture out. I mean, that’s violating the contractual agreement to store the furniture. I mean, it’s called a bailment. It’s not, you’re not loaning the warehouse company, the furniture you’re turning it over to them for specific purpose to store.
Stephan Livera:
Yeah. And then in terms of a loan, so let’s say there’s, you know, full reserve bank offering, operating in Bitcoin world. And then I guess the key point to understand is that if you are a customer of this bank and you want a loan, that bank is only giving you the loan from funds where somebody else has willingly is foregoing their use of that money, as opposed to today’s world where it’s kind of like, you’re sort of playing both sides of it because you’ve got it, it’s there in your account that you can spend today, but it’s also being loaned out if that makes sense.
Joseph Salerno:
Yeah, no absolutely. So there are ways to make loans so for people who want to earn interest and don’t need the immediate availability of that deposit of Bitcoins can deposit it in a time, a true time account, an account, you know, which has a maturity date that is, they can’t withdraw it until it matures 60 days from now, a year from now. I mean, that’s what a bond is five years from now. So the banks can issue those sorts of accounts to their customers. And that would not be credit expansion because the borrowers can have access to the money for that, the term of the certificate, what you do not as a depositor.
Stephan Livera:
Excellent. And when it comes to, as you mentioned so I guess let’s talk through that example. So then the customer is the important part is the customer is going there and saying, okay, Mr. Banker, I’m giving you this, you know, two Bitcoins and it’s in a term deposit for, you know, a year and I cannot access it in that time. And then that banker then can turn around and offer that out as a loan. So long as he’s not expanding beyond the amount of actual Bitcoins he has in his overall vault.
Joseph Salerno:
Right. Right. Basically there’d be a separation between deposit banking, which is not a loan, which is what we call a bailment in legal terms where the bank is only storing or warehousing your money and shifting it among accounts when you write out a check, right. In order to the bank to shift that to someone else’s account. So that, and, loan banking. So there would be a strict divide between the two and any mixing of deposits. Then using of the deposits on the deposit side for loans on the loan side would be considered embezzlement.
Stephan Livera:
Exactly. Right. And I think one interesting thing that I find about Bitcoin is that in some ways, it is, well, it’s extremely subversive that people can actually save their money in a way that’s outside of the government. And that may also drive certain changes in the way governments can inflate because now they can’t inflate. Even if they know how much you have, that would still drive or arguably it might drive a reduction in the size of the state, which I guess we’d like that.
Joseph Salerno:
Yeah, no, you’re absolutely right. I mean should something like Bitcoin, which has a supply that is beyond the reach of government manipulation, should that become the general money or the general medium of exchange, which is money. Then, the state would have to raise taxes in order to fund its various programs. And it would no longer be the Santa Claus state, which just bestows, you know, gifts on everyone will while seemingly not increasing anyone’s taxes, at least in the short run. So yeah. That’s wonderful.
Stephan Livera:
Right, and I think.It’s also fair to point out that the government has set up well around the world, governments around the world, set up this kind of environment where there’s inflation occurring, and then there’s also a capital gains tax. So then it basically, they’re trying to tax the accumulated wealth of the population because over time, the nominal value of your property, of your house or different assets are rising, and then as people turn over and sell them, that’s where the government is coming at you for their capital gains tax pound of flesh. Right?
Joseph Salerno:
No, that’s absolutely true. And a progressive income tax of course takes a greater proportion of the same amount of wealth because inflation will push people. If it’s not indexed, it will push people into higher and higher tax brackets where they have to pay a great proportion, even though the real value of that wealth has not increased. And that’s, you know, that’s monstrous.
Stephan Livera:
Right. And that’s a lot, I don’t know, maybe this is an Australia specific term, or it’s a global term, but here that’s called bracket creep where basically over time, just because of inflation your salary is rising, but your tax, which pushes you up into higher tax brackets, you’re paying even more to the government. So I guess in terms of, we just got a question from the chat here with, so let’s say we had separated loan and deposit banking how would a bank make money from deposit accounts? I presume this would just be more like they might charge a fee for service for offering this kind of thing.
Joseph Salerno:
Yeah. I mean, they would charge a fee for service that has been done in the past. It’s done currently when you, when you store anything with a warehouse, when we have to start to think of banks, deposit banks, as simply warehouses that are giving us certain conveniences that is relieving us of the risk and of storing and inconvenience of storing the money of doing the accounting ourselves. In other words, if we have a checking account at the bank, they’ll do the accounting for us and so on. So that’s, yeah. We’re paying for conveniences.
Stephan Livera:
Yep. And sort of like paying for access to the ATM network of that bank, or, I mean, I guess that’s it, although nowadays it’s very digital, so it might kind of operate in a more digital way rather than physically getting cash out of an ATM, but it’s a similar principle that they’re providing the infrastructure and then you pay for that service, I guess. Now Dr. Salerno, I would also love to talk about your critiques on monetary velocity. I think those were excellent. And I think this is a common confusion that I see amongst people in the, maybe not so much in the Bitcoin world, but out in the kind of quote unquote crypto world they talk a little bit about monetary velocity and thinking, you know talking about like high velocity and low velocity, but I think the concept is quite bunk. But perhaps we should just make sure for the listeners that they can follow along. Could you just outline a little bit around what is this whole MV equals PQ?
Joseph Salerno:
Yeah. So what you can think of the following example, let’s say that there’s a, you know, a thousand dollars in the economy and during the year, so you take some arbitrary period of time. There’s been $10,000 worth of goods produced and sold. Well, there’s, there’s a mystery there. I mean, we all, there’s only a thousand dollars in the economy. How can we have $10,000 worth of goods sold? Well, you know, the economists step in and they say, well, of course, you know, money can circulate at different rates. So some dollars could turn over 20 times during that year. Other dollars may turn over only two or three times, but the average is 10, right? We have $10,000 worth of spending divided by the $1,000 of money in existence. So that must mean that we have a velocity of 10 for the dollar, but that’s absurd.
Joseph Salerno:
Velocity is a meaningless term. It doesn’t have any effect on value because people often say, well, when velocity of money goes up prices will go up. Right? So you know, just like, so velocity operates like an increase in the money supply. If there’s an increase in velocity or an increase in the money supply for either reason, if people spend money more quickly than they can drive prices up. But think of it this way. Right now, as we sit here at this moment, everybody has certain amount of cash in their bank accounts and in their purses and wallets. Tomorrow we’ll all go into the market and we’ll spend a proportion of that and we’ll keep the rest for ourselves and for future purchases where there’s, where is there any velocity? There, there is no velocity money.
Joseph Salerno:
Money is simply exchanged like any other good. So one economist Nassau Senior, who’s a classical economists during the 18th century, mid 18th century, he was brilliant on this. He pointed out, he said, look, he says, houses, change hands, but we never talk. And houses have a certain velocity. And another French economist pointed out that art for example, is held. And then exchange that has the velocity, does the velocity of houses or art affect its value. Of course not. It’s actually the other way around. We decide on the price for certain things. If the price looks good, then we exchange it. So velocity is an empty concept. It’s something that we should avoid using and especially not use in our theory of how the value of money is determined.
Stephan Livera:
That was a fantastic explanation. So let me just replay some of that just for the listeners to make sure everyone can follow along. So I think we could summarize this one of Murray Rothbard’s critiques in fact, was that at all, given times money is resting in somebody’s cash balance and it’s not circulating so to speak. Right. And now I think one of your critiques Dr. Salerno, And I really enjoyed this, I can’t remember which article it was from, but essentially it’s that point you were making, which is that price is antecedently established by the different parties. Right?
Joseph Salerno:
Yeah. Right. So when we go into the market tomorrow you know, to purchase the various goods and services, that we demand as consumers, and there’s where we are facing the sellers or vendors of those goods. There’s a subjective interaction of the values of the sellers, of the values of the buyers and that establishes prices. It’s only at that point that the money changes hands in other words, many people, and unfortunately some Austrian economists that are, call themselves, free bankers, look at it this way. Many people think that, well, there’s a certain price level and then money floods in and pushes this price up or it drains out and lowers it, but that’s not, but money doesn’t push prices up or down to the other way around money exchanges, hands only after people have valued money versus goods and prices are determined on the market. So that’s a very important point and many economists don’t understand that.
Stephan Livera:
Yeah, that was fascinating. I think that’s a really great, because I think there’s a common confusion, right? So maybe not as much nowadays, but a couple of years ago, you would see people in the, again, quote unquote, crypto space where they would talk about MV equals PQ, and then they, Oh, well look, say if we slow down the velocity,
Stephan Livera:
Then that might mean this token holds its value more. And it just seems like fallacy on top of fallacy on top of fallacy. Right. And I think this is a, this is an area where I think more people should think a little bit more clearly when they’re thinking about what does it really mean to talk about monetary velocity again, does that even, does it even make sense? Right. So that’s look, another area I’d really love to chat about is your explanations on deflation, because this is one of my favorite articles to tell people to go and read, because I think you were just way ahead of the typical person today. Who’s like saying, Oh, no, deflation is bad. Really we have to understand what are the causes and split up that deflation into components. And I think you do this in your article, an Austrian taxonomy of deflation. So I think I guess if I were to just summarize it for people to make it easy for them, it’s like, we should think of it. Like there’s growth deflation. That’s the good kind. And then we’ve got the bank credit deflation, which is sort of superficially, it looks bad, but actually is also another part of the process.
Joseph Salerno:
Yeah. Yeah. So let’s start with growth deflation. I mean, I often ask my class do you like low prices? And they all say, yeah, yeah. You know I asked, you know, what would you prefer if an iPhone was only 10% of, you know, if it was $60 instead of $600 and, yeah, yeah. They all think that’s great. And I say, well, do you think that’s good for business? And everyone says, no it’s terrible for business. But the point is this, in a capitalist economy that is operating without the government intervening in the money supply and increasing the money supply, what occurs is that there’s continual competition, continual competition for ways of making the production cost lower of lowering the price of different things. So when that occurs through new technology and new investment in better and more capital goods, labor becomes more productive.
Joseph Salerno:
Each laborer can produce more. And so therefore we have more goods in the economy now, how are they going to sell these additional goods? People are buying all they want at the going prices. They have to lower the prices. So to make a long story short, growth deflation, the fallen prices is a result of the growth in productivity and the increase in improvement in technology and so on. So the HDTV in Japan was sold for $36,000 back in the 1990s. And today for an HDTV, that’s much larger, much more much higher quality, better picture, more pixels per square inch and so on and so forth is $500. The same thing has happened with LASIK eye surgery, for example, where it used to be $7,000 per eye. And, and today it’s, it’s you know, a $300 or $400 per eye, but the point is are we better off with the deflation?
Joseph Salerno:
We are. What about the companies? Well, in fact, despite the fact that price of computers of all types have fallen tremendously by 90%, you know, since PC’s were first introduced, for example, or if you go back to mainframes, mainframes were about three, $3 million, but now a laptop has more memory and is faster. How did they stay in business when these prices plummeted? Because they had lowered the costs in advance, through competition and improvements in technology and lowering of costs of production due to more and better capital goods and robots and so on. So that’s growth deflation. That’s very good. Bank credit deflation is an unfortunate consequence, but it’s necessary of the fact that the central banks have previously inflated, artificially lowered interest rates and lured entrepreneurs into making bad investments. And then when that has occurred and the central banks have stopped increasing the money supply as quickly, then the prices begin to fall and, and interest rates rise. And these things become unprofitable. And you begin to get business bankruptcies. And so on. The problem then is if you don’t have a central bank, bailing people bailing out institutions, bailing out banks. Well, then what happens is that these banks fail as they did in the 1930s. And you get a bank credit deflation, which is necessary because the banks have made these, these very bad loans and mal-investments have been made by bad investments by the entrepreneurs. So it’s a way of correcting that whole process.
Stephan Livera:
Yeah. And I suppose with that, because often the government will have, you know, occupational licensing and all these other things that make it difficult for people to readjust the right. So it’s kind of like we’ve built up these mal-investments over time, and people then might find it difficult to now change and find some other job in some other industry when really that’s where they should have been all along.
Joseph Salerno:
Right. Well, that’s a great point actually, because the way to mitigate the recession and make it end more quickly and make its effects less devastating is to get rid of things like minimum wage laws, special privileges that unions have that allow them to keep wages above, especially during a depression above the market levels. Occupational licensure, as you pointed out, which keep people out of certain professions, you could, you could really make it a depression much less severe if you could, while it was going on, begin to make these reforms. So that was a very good point that you bring up.
Stephan Livera:
Great. And also, I think the other question people have in their minds is we’ve well, basically in living memory, we’ve all been living in an inflationary environment. So we’re used to this idea of prices rising over time. And I guess for some people, they might now flipping it back the other way. Like, imagine we lived under a gold standard or potentially under a Bitcoin standard, we would be living in a world of beneficial, growth deflation. Now, some people might come back and say, well, hold on. If I’m a business owner, how am I going to make it work? If my the prices for the things I sell are coming down over time, or if I’m an employee, how would I be comfortable with having my salary? The nominal salary might be actually dropping over time, right?
Joseph Salerno:
Yeah. Well, let’s deal with the business owner first. The business owner is not interested in the absolute level of his prices. He’s interested in the margin between his prices and the prices he pays for the inputs that he uses, which are his costs of production. So in a dynamic capitalist economy, the costs of production are falling tremendously. And in fact, we know that there are there the computer industry has grown tremendously despite this plummeting in prices by 90% for chips and so on. As far as the workers are concerned, their nominal wages won’t change much unless there’s an increase in the population in the labor force. So what will happen is that prices will fall. The nominal wages won’t increase, but they won’t fall. They’ll just become more productive. So you know, if prices fall by 10% and their wages stay unchanged, then they’ll have a 10% increase in their income.
Stephan Livera:
Yep. One other question I had on my list and I just thought of it recently as well. So Murray Rothbard in, I believe it’s Man Economy and State, he talks about this idea of medium of exchange being the most kind of the it’s like the quintessential or the defining characteristic of money. Is it possible though, that kind of coming back to that idea of, you know, large wealth transfers is it possible that money could arise even though it’s not being used for like coffee and bread and kind of day to day transactions, but it just takes time, even though the medium of exchange is still the defining characteristic of money, it’s just that it kind of, it might move through these stages. And I think potentially that also comes up in Jevons and other writers where they’re saying, okay, it starts collectible then store value and medium of exchange, then unit of account. What’s your view on that? And do you have any thoughts on how to, if you will square that circle?
Joseph Salerno:
Well, I, to the extent that it becomes, is used as a store of value, or it’s used a, you know in religious rituals, if that, if it becomes more and more generally acceptable, at some point it will then become people realize that, and then they’ll trade their less saleable goods for that thing. And it will then assume the role of a medium of exchange. I mean, we can go through different thought experiments, you can think of how that could happen. And that with gold and silver, they were used for, as I said, conspicuous consumption for, you know, showing off one’s wealth for religious rites and so on. And so they were very well. And also for aesthetic purposes, people thought they were beautiful. So there were these other uses initially, and people may have very well kept their wealth in that form in fact, they kept it in the form of plates, gold plates and ornaments and so on. And then when people realize how generally acceptable it was, they realized this is one of the, this good will be very, very saleable because everyone accepts it. So, yeah. I don’t see any contradiction there with the Mengerian story.
Stephan Livera:
Yup. Yup. And I guess I’m also reminded here of the point that one of my favorite kind of quick essays I can offer to people. I cause people ask me, what should I read? And one of my favorites nowadays to recommend for people in the Austrian tradition is Dr. Hans-Hermann Hoppe’s essay, How is Fiat Money possible? And in that essay, he makes this point about how, you know, people might’ve superficially thought, Oh, you need like a different money for different trading areas. But then the point that a hopper makes there is that really think of it more like, imagine if you had one global trading area that would be far bigger from you know, a network point of view than each individual country having their own Fiat money. Right. And I think that is a good, interesting thought experiment for people to imagine. Well, wouldn’t that be better if you could just trade globally across this whole network?
Joseph Salerno:
Yes. Because you would save the costs of inter network trading right. Of exchange in currencies that would have to be resources devoted to that providing that service of exchanging the currencies. So that’s absolutely true. I mean, Hans saw so deeply into that problem. I think he put it in a very good way, his explanation.
Stephan Livera:
Fantastic. And so I think I’d love to also chat a little bit about monetary reform. Now we know the government is not necessarily gonna listen to people who are saying, you know, take yourself, get out of the way, let the market decide what the money is, but hypothetically, what are some of the ideas that could be posed as improvements on monetary reform?
Joseph Salerno:
Yeah. So just the, to your first point, the point you just made though we really don’t want government to get involved in monetary reform. I think Rothbard thought that you know, at some point we could have had the government take us back to a gold standard, and I even thought that way, but I don’t think, you know, with what we know about governments, especially today, with the way they’re printing money up, that’ll never happen. And we can’t trust them to carry it through. So what I think should be done is that we should push for the right to hold foreign currencies to have a gold and silver detaxed that is take all excise taxes, sales taxes capital gains taxes off of gold and silver, and allow contracts to be enforced that are made in gold, silver, and foreign currencies or Bitcoin or anything else.
Joseph Salerno:
So what we need is currency, what we need is, you know currency competition, and currencies, which was Hayek’s idea in a very, a good pamphlet that he wrote back in 1975 that I highly recommend on currency competition before his Denationalization of Money, where he advocates private, Fiat currencies. I’m not so crazy about that, but, but I’m just allowing people to use any kind of money that they desire and have it enforceable, and don’t try to tax it out of existence.
Stephan Livera:
Right. And I think it’s worthwhile thinking about what would make most sense. And I think, as you’re saying, this is kind of the, you’re asking for less, right? You’re just saying, right.Let people decide what they want to use as their money and you know, let the market decide. Right. And now obviously we know the government is not going to do that anytime soon, but it’s I think it’s educational for people, nevertheless, to think about the implications, what would happen if we were to remove capital gains tax, let’s say?
Joseph Salerno:
Yeah, no, I mean, people could, gold would look better as a medium of exchange or as a secondary, medium of exchange if you got rid of these taxes on them.
Stephan Livera:
Right. Yeah. And I think, because right now it’s because of things like capital gains tax, it just, it becomes too onerous. And you’d now have to do accounting. You have to now think about, okay, well, what did I buy? What was my cost basis on this? And it just it’s like this incredible administrative and onerous burden that basically nobody does. And so now it’s almost like a I guess, a little bit going to that idea of Bitcoin as potentially kind of like Uber strategy, right? Like Uber just kind of got out there and it got used enough that there were enough people who kind of demanded that, Hey, we want this now. So yeah. I wonder if potentially Bitcoin is kind of like an Uber strategy in that way of getting people to kind of just use this alternative money that is hard to inflate and hard to stop.
Joseph Salerno:
Yeah. I mean, that may very well be what happens. I think there has to be something that some event not necessarily catastrophic, but an event that shakes people’s confidence in the government and the dollar and the way it’s being issued. And I think this inaudible the way they’re throwing money at everything, certainly in the United States may very well cause a rapid consumer inflation. I mean, asset bubbles, people don’t understand asset bubbles, but they do understand a huge increased rise in the price level that significantly reduces or dilutes their purchasing power. So that may push people towards Bitcoin.
Stephan Livera:
Yep. And actually, just while you were mentioning this idea of inflation and under this current scenario as well, because I think this is another area where people talk about velocity and they say, Oh, well, see, now the velocity might be really high and that’s going to drive the inflation. But I think that’s not really what drives it. Right? It’s more about probably it’s more about inflationary expectations going forward, would you say?
Joseph Salerno:
Yeah no, it’s inflationary expectations. Now people make more frequent transactions because money is beginning to lose its role as a store of value. It’s still a medium of exchange. People will accept it, but with the idea that they’re going to get rid of it in the next day or two, I mean, that’s what happened in Germany during the hyperinflation, literally towards the end, workers were demanding to get paid two and three times a day and their families would be at the factory gates and they would give their pay envelope. So their families would rush out and spend it on different goods and services. But that’s all that means is that the value people’s subjective value of money is going down in relation to goods. So they’re trying to purchase.
Stephan Livera:
Yup. And so I guess that’s sort of like a, I guess the quick way to say it is like monetary hot potatoes, right. Nobody wants to hold it for too long because they’re worried that what the value is going to drop. And I guess that is potentially a difficult question because people want an answer, right. They just want to say, Oh, well look say the central bank did all this liquidity and all this, you know, base money creation, but really what’s driving. It is that kind of gradually, then suddenly a conception in everyone’s minds of all, I’m expecting more inflation. And eventually you just sort of hit a tipping point. Would you say that’s right?
Joseph Salerno:
Oh yeah. Right. That’s where money begins to lose its value hourly where there’s a significant drop and at that, but then you get rushing to purchase different goods and services. And eventually then the price level rises to infinity, which means you can give them the whole money supply of the country. And a farmer won’t sell you a dozen eggs, which is what happened in Germany.
Stephan Livera:
Right. And so I guess for a long period of time, it looks like everything is fine, but then it just sort of, sort of flips. And I guess if you’re in the government at that time, you have this temptation because you’re worried about, I’ve got this big hole in my budget. I need to, from the government’s point of view, they want to inflate more and more. And they, at the, I guess at the start, they might inflate a little bit and see, Oh, it didn’t, it didn’t cause too much inflation. So I can, I can do a little bit more. And then it just, I guess it starts this feedback loop.
Stephan Livera:
Right. And then that’s when the real problem happens.
Joseph Salerno:
Yes, you’re right.
Stephan Livera:
Yeah. So I think our listeners, if you’re interested, check out, I think that, I think that point inaudible makes that point in the mystery of banking. So definitely go and check that out. Dr. Salerno I’ve really enjoyed chatting with you. I’d love to chat more, but I think this is all we’ve got the time for today. But listeners, make sure you follow Dr. Salerno, go and read his book. Money: Sound and Unsound. Find him at mises.org. Your Twitter is @jtsale. Is it?
Joseph Salerno:
Is it yeah.
Stephan Livera:
Is there anywhere else you would like people to follow you online?
Joseph Salerno:
No. No, that’s it. That’s it. Thank you.
Stephan Livera:
Excellent. Well, look, I’ve really enjoyed chatting with you. Thank you for joining me.
Joseph Salerno:
Thanks for having me on.
Stephan Livera:
Alright, listeners. And you can find me @stephanlivera.com. See you guys in the citadels.