Jonathan Newman, Associate Professor of Economics and Mises Fellow joins me to chat:

  • Contrasting definitions of inflation
  • How did Mises define inflation?
  • How did Rothbard define inflation? 
  • Where and how does fractional reserve come into it? 
  • Cantillon effect and the Mises effect
  • Costless production of money



Stephan Livera links:

Podcast Transcripts:

Stephan Livera 00:00:00

Jonathan, welcome to the show.

Jonathan Newman 00:00:02

Hi, thanks for having me, Stephan.

Stephan Livera 00:00:03

So, I had a look at the paper that you wrote along with Christopher, and I thought was an interesting one about inflation. Of course, there are big, big debates all around the world, not just in Austrian circles but in the broader world about what inflation is. How should we define it? How should we think about it? I thought it would be handy to get you on and talk a little bit about that. So, do you want to just start with a little bit of your motivation? Like why did you write this paper?

Jonathan Newman 00:00:28

Sure, it’s a very hotly debated topic even in the past few years in popular media, where people are talking about what inflation is and where it comes from. You see in the media people talking about how supply chain issues cause inflation. You even see a lot of people talking about how greed causes inflation. And as silly as that is, but of course, you know, going back in the history of economic thought there. There used to be a well-established definition of inflation that involved an increase in the supply of money, especially an increase in the supply of money or the supply of notes beyond the amount of gold that existed in the economy. So that used to be the definition, but then you know, since the Keynesian revolution and other changes in the history of economic thought, we’ve sort of meandered from that idea to the idea that inflation is a rise in prices, and of course that is a consequence of inflation. But it’s not inflation itself. So, in this paper, we try to. But like we try to settle on a really good definition of inflation, that’s suitable for doing economics and that it’s good and it goes along with the rest of the Austrian literature. But unfortunately, there’s actually like you mentioned, there’s some debate even between Austrian economists and differences between Austrian economy. Even between the big names like Ludwig von Mises and Murray Rothbard, had slightly different definitions of inflation in their works. And so, in our paper, we talk about how Rothbard’s definition is the best for doing economic analysis, and the main reason why is because it makes use of counterfactual reasoning. It compares one timeline with an alternative timeline. And that’s really the best way to do economics and think about changes in the economy. So that’s why we settled on Rothbard’s definition.

Stephan Livera 00:02:19

And that’s I gonna think this is something where most people I would say a lot of Austrian-influenced people are probably using the Mises definition like in terms of how they just think about things will get in. We should get into that in. Explained that but the way you know the way I’ve often thought about it is the mesas style. Any increase in the money supply is inflation. But do you want to explain a little bit about those definitions? So, can you give us, you know, the mises definition and what’s the Rothbard definition?

Jonathan Newman 00:02:46

Sure, in some of Mises main works, he defined inflation as an increase in the supply of money in excess of changes in the demand for money. So, if there’s an increase in the supply of money that’s not matched by a change in the demand for money, then you have the decrease in the purchasing power you have the change in the price level and so you have those sorts of consequences. And the thing about that definition I mean it’s that is useful if that’s the sort of thing that you’re trying to analyze. The thing about that is could apply to a gold standard. It could apply to cryptocurrencies, it could apply to Fiat money, but also to a fiduciary media. So, whenever there’s any sort of increase in the money supply, no matter what that money supply is constant. What constitutes that money supply? Is it in excess of money demand? Then you that would be inflation in the mazian.

Stephan Livera 00:03:48

I say and then what’s the rough body and definition?

Jonathan Newman 00:03:47

So, Rob, I actually have it right here so in Rothbard’s version in the man economy and state, he defines inflation as the process of issuing pseudo warehouse receipts, or more exactly the process of issuing money beyond any increase in the stock of specie. And of course, but specie he’s referring to gold and for warehouse receipts he’s referring to bank notes. And so here Rothbard is showing that inflation is something that happens. Outside of the market, inflation is something that happens when the banking system, through fractional reserve banking or through a government that’s issuing paper notes. If they do that in excess of the total stock of gold that exists then that in, in Rothbard’s view, that counts as inflation. So, there’s a slight difference there, in Rothbard’s version, there’s no real reference to the demand for money and the reason why is because the demand for money will fluctuate and go up and down in the market economy on its own. On and so it’s best to sort of set that aside and just focus on the change in the supply of money and what is instigating that. And so, from Rothbard’s perspective, it’s if there’s an increase in the amount of paper or claims to money in excess of the total stock of gold.

Stephan Livera 00:05:10

I say yes, so yes, so summarizing then as Mises defines it, its inflation is an increase in the money supply as long as it’s also that there’s a connection there associated with the increase in demand for money. But Rothbard is putting it in terms. 

Jonathan Newman 00:05:18


Stephan Livera 00:05:20

Of the actual, you know, issuing money beyond the stock of specie. So, I’m curious then, and this also kind of veers over into the whole full reserve and fractional reserve debate. And now I’m personally in the full reserve camp, but does that mean your opinion might sort of turn based on if you’re a, if you’re a hopian rough body and full reservist? Or you are a soldier, Nite, you know, quote UN quote free banker who believes in, let’s say, fractional reserve banking as a legitimate process. I guess does that kind of turn your opinion might turn on this question, right?

Jonathan Newman 00:05:51

Well, I think that depends on the sort of connotation that you have with the term inflation. So, if you don’t want your policy prescriptions to be associated with the word inflation, then I can see how that would happen. But I mean, even in like just like an objective, unbiased sort of sense. The consequences of fractional reserve banking do result in the same sorts of things that happen when there’s an increase in Fiat money, namely that there’s this expansion of claims on the base money. Beyond the amount of base money that exists, so in that sense, I just objectively they’re similar and they both fall under Rothbard’s definition it so really you would only have that sort of difference or that maybe that pushback from those guys if you if you just didn’t want that term inflation to be associated with your sort of desired monetary institutional setup.

Stephan Livera 00:06:48

Yeah, so I guess in a theoretical sense, it shouldn’t change your view, but in the sense that if you want to be seen as anti-inflation, then you might not like that definition because you know, as you’re saying the rough body in view because rough body was anti fractional reserve banking and this view is sort of more aligned with his definition where you know I mean to make a simple example let’s say there’s a hundred pieces of gold in the economy and there’s, you know, 150 tickets that are paper claims. For those hundred, you know those fifty what we’re talking about is that 50 difference is fiduciary media. And you know the creation of those tickets, let’s say those extra 50 tickets above and beyond the 100, you know, gold, oz or gold pieces, that’s inflation, that’s fiduciary media, correct.

Jonathan Newman 00:07:32 

That’s right yeah, so you, I think you got it exactly right. So, if they don’t want that term inflation associated with their view then they might push back against this. Otherwise, I think it works.  One of the key similarities between an increase in fiduciary media and an increase in Fiat money is that it’s something that runs counter to the choices by market participants. So, in the case of fiduciary media, and I know that there I Know there are all sorts of arguments. Going against what I’m about to say, but in the case of fiduciary media, that’s an increase. In the supply of money that may or may not be matched by a change in the demand for money, but it’s definitely at least it’s not certainly matched up with the supply of savings and people’s desire to save. So, our point in the paper is that there’s this mismatch between what market participants choose and how the money supply might react to people’s change in preferences and the definition that Rothbard offers really does distinguish those two outcomes, or those two processes.

Stephan Livera 00:08:40

I see and so. Let’s put it this way, and this is maybe coming to a similar kind of conversation that maybe readers might have learned from reading Getter Hillsman the ethics of money production, right? So, there’s this notion that as you know, new money is created under a free market scenario, right? Not government scenario. There is some, you know, legitimate purpose in that, you know in the pre-Bitcoin world let’s say. That you know, there are people trying to produce gold, like, literally trying to go out and mine and refine it and produce it and make gold coins and, you know, and so on. And I think the important point that you spell out in the paper as well is, you know, they paid the costs for it, right? It wasn’t just X hello, I’m the government. I’m, you know, Darth Vader. Pray I do not alter the deal any further style. Right? Because those gold producers actually went and had to dig and do this work. To create the thing as opposed to in the Fiat arena, it’s just today, its dollars, it’s numbers on a bank account. It’s numbers in a data based somewhere.

Jonathan Newman 00:09:40

That’s right, so the in the case of any sort of market produced money, the market is going to choose a money that has some sort of constraint on its production otherwise, otherwise, the money would just very rapidly lose value. And really the, the only reason why Fiat monies don’t lose value as fast as they would is because of the interventions by the state. So, if you have legal tender laws, if you have all sorts of other things that are sort of propping up this this system. Then it can maintain itself, at least for a while. But of course, as we all know, all Fiat monies are gonna end in disaster.  But in the case of gold or like you said, in Bitcoin the supply of it has some sort of constraint. I’ll mention gold since that’s what we talked about in the article. So, a gold producer has to pay for factors of production. They have to pay employees. They have to buy the land. They have to do. They have to buy capital goods and drilling and mining equipment to have to buy all these things just to get the thing out of the ground. And so, what that means is the supply of gold on the market is constrained by prices and very specifically the prices of those factors of production. But I mean since what matters is the relative prices of these things, it means that there will only be an increase in the supply. Of gold in A in a pure gold standard. If the market actually desires it. If prices are such that it is profitable and productive to increase the supply of gold.

Stephan Livera 00:11:14

I see and I guess to be clear, none of this contradicts the sort of original insight that any supply of money theoretically can serve the role of money, right? It’s not that, you know, because this is another common confusion, right? A lot of people believe that. In order for the economy to grow, the money supply has to also grow. And that’s not true, is it?

Jonathan Newman 00:11:34

Not true at all, and that was a part of the original sort of rhetorical. Tricks that were used to get the Federal Reserve started. So, the idea was that we needed an elastic currency, that one that could expand and contract with the economy specifically. Expand so like the idea is that if the economy grows, then the need of trade grow and therefore we need additional money. But of course, that’s not technically true, because prices can adjust. So, since prices can adjust, then it means that any supply of money will do with the important asterisk.  As you mentioned it’s any supply of money that is selected by the market so if it’s profitable to produce additional gold, then you can do that and that might mean that you don’t. Have to have all of the prices. Adjustments that would have happened without the increase in the money supply. But the point is, it’s the market that chooses it’s the economy, through all, all of the important interconnections and the structure of production through everybody’s preferences being revealed through action. It’s the economy deciding should we increase the money supply or should we change prices so in the case of a gold standard, any increase in the supply of gold doesn’t have the inflationary consequences that the increase in the fiduciary media or in Fiat money would have. And the reason why that we pinned down in this article is because market participants select it. Market participants decide to go through and do it and purchase the factors and produce the additional gold.

Stephan Livera 00:13:13

So, is there any? Do you have any comment on why that might be like? Why would they demand more monetary units or is that, you know, unanswered or you know, we don’t really fully know.

Jonathan Newman 00:13:24

Well, so we as economists, we can sort of take a step back from those sorts of questions. It doesn’t really matter if they go about and do it or if they produce additional gold then their actual reasons for doing so don’t really matter in the case of a. A gold standard and a gold producer. All that, all that has to happen is that it’s profitable to do so. So, what that means is they can produce more gold than it then they have to spend to produce it. So, suppose they. Have to spend 100 ounces of gold and in so doing, they purchase factors that allow them to produce 105. Ounces of gold. As an output, that’s a 5-ounce increase in the supply of gold. But since it was based on that price difference, it means that the market, the rest of the economy was OK with that sort of thing that’s a productive value. Thing and to sort of drive that point home, we actually relied on another contribution from Rothbard that’s called demonstrated preference. So, in that case the increase in the supply of gold is based on the demonstrated preference and the unanimity principle such that everybody that’s involved in the increase in the supply of. Gold and the. The spending of it and the receiving of it as income was preferred by market participants like it because they went through and did it on their own. But in the case of Fiat money and also fiduciary media, it’s that’s not it’s at least not as clear. There’s not a there’s not a connection between the changes in the. Supply of those. And the preferences of market participants so, so I know that’s I’m sort of like wiggling through your question there, it’s the they might want they might want to mine more gold simply because it’s profitable to do so they might want more gold simply because. Of just the size or like the convenience of the size of coins and the convenience of the of what can fit into a bank vault, all sorts of considerations can go into that, but, but you’re right that at least at least theoretically, any supply of money will do as long as prices can adjust in general.

Stephan Livera 00:15:36

And I like the point that you made that the gold you know, in that scenario, let’s say the world was on a gold standard. The gold manufacturer is operating on a personal gold standard, right? He’s thinking, can I outlay these 100 pieces of gold to get 105 pieces of gold like he’s profitable in gold terms. And obviously for Bitcoin listeners then? And in a Bitcoin world, it would be like this Bitcoin miner is thinking I’m gonna outlay, you know, one Bitcoin to earn one point. 05 Bitcoin or whatever, right? So, it’s the same kind of thing. He believes he can profit in Bitcoin terms, and that’s the important point. And then I think the other point you’re making is that when you distinguish between market chosen money chosen voluntarily by the people and then the fiat Not political money, where basically it’s a political decision. It’s a policy choice. And so, there’s a big distinction there. And I think this is probably the other point you were making, which is that in that scenario of actually free market money, sound money producing more money, it’s still socially beneficial. Whereas in the Fiat money world it’s more like its sort of more in the value extractive sense because maybe the. And just kind of taking resources from, you know Jonathan to give to Stefan or from one person to give to another because that’s kind of where we’re getting into more like the panteon effect or the misses? Effect particularly, right?

Jonathan Newman 00:16:53

Right. So, you’re right that a lot of the previous authors would say that. So let me actually let me back. Up a little bit. Some people would criticize the gold standard and say, well, if any supply of money will do, then isn’t it wasteful for us to increase the supply of gold to dedicate resources to mining more gold. And that’s one of the questions that we address in our paper. And so Rothbard, his answer to that was well, Roth. Excuse me? Gold has. Other uses besides its use are money. So even if. Some of it will enter into the money supply. The fact that we’re using more resources. To mine more. Gold, since it has other uses, it’s still socially. It’s not a waste for us to increase. Gold mining and well, I think I think that’s true. We wanted to be able to generalize this to any sort of market-selected money including in the case where Bitcoin or other cryptocurrency is selected. And the reason why is because it’s not. It’s not as clear that there are alternative uses for some. Of those things. Besides, it’s used as a medium of exchange. And so, we wanted to. Be able to say well. Even in those cases, it’s still socially beneficial for. The supply to increase. As long as market participants decide to do it, as long as it’s voluntarily chosen and that’s where the demonstrated preference aspect comes in is that if market participants decide to have this monetary institution where it grows algorithmically or it grows by people participating in. If market participants decide to do that, then they have chosen they have demonstrated. Preference for that.  Increase in the supply of money. It independent of all other things that a government might do. So, and of course, like you said, in the case of Fiat money, it’s totally. Independent of the market, it’s somebody’s decision to increase or decrease the supply of money usually. Increase and the reason it’s usually increased is just as you said it’s because it’s a method of an extraction of resources from the market. So, you can. Think about the market as this. This engine of productivity and we’re producing tons and tons of stuff and the government has a few different options of how they can acquire those things from the productive economy. They could tax it, which is very, or tax people on the market, which is very unpopular. People don’t like taxes or they can print up new pieces of paper money that they can then spend into exist and spend into the economy and acquire resources. So, you’re absolutely right. And it’s because of that huge categorical difference between those two inflations or those two processes that we decided. To say well. Let’s call in. This one inflation, the one that’s outside the market, the one that has those sorts of consequences. We’ll call that inflation, but the one that belongs to the market and is where changes in the supplier decided by market participants, we can still talk about an increase and decrease in the supply of money but maybe draw a line between them and say this one is inflation and this one isn’t.

Stephan Livera 00:20:02

And let’s get into this effect. The Cantillon effect and also the mazes effect, which is a specific, you know, I’m reading that as a specific type of Cantillon effect, right? As I understand it kind of it’s the insight that money is not neutral. It matters who gets that new money 1st. And so, when we’re talking about the production of new money. I guess you could sort of say the guy who’s making that new money 1st and maybe the first few people who he spends it with, that they’re kind of winning in, in the Canton effect, right?

Jonathan Newman 00:20:35

So, and that’s the reason why the government is able to do that extraction, that expropriation from the market, it’s because the whoever spends the money first gets to lay claim to those goods and services that are produced by the market before prices rise. So, they get to get those things. And then everybody else. Well, not everybody. But as the new money is spent, obviously the purchasing power of the money unit decreases, prices rise, and so everybody that’s later in that chain has to pay for that original expropriation in the form of higher prices. And so, this is why inflation is sometimes called an inflation tax. It’s because whoever spends it first gets that initial benefit. Other early spenders also get to receive higher incomes before prices rise, like at their own grocery store. But then later on in that chain, as I said then, there are losers. There are people whose incomes have not risen and might not ever rise. But they have to pay the higher prices. So, this sort of imbalance in the way money is introduced into economy, as you said, it’s called the Cantillon effect in the case of the missis effect, which is a particular version or particular type of the. Yeah, an instance of the Cantillon effect, it’s when the money enters the economy through credit markets and has an effect on interest rates and therefore causes all sorts of changes in the production decisions that entrepreneurs make. And this and this, of course, is what Meese’s it was this line of thinking that allowed Misses to talk about the business cycle. So, if there’s that increase in the supply of credit, that changes interest rates, then production gets lengthened. There’s an increase in consumption as well. We have a bunch of people changing their production decisions in such a way that can’t be completed, so there’s only a certain amount of resources in the economy. And if you try to change the structure of production and by lengthening it, then those new projects that you start won’t be. You won’t be able to complete them, at least not profitably. And the reason why is because of the simple scarcity of resources. So normally the way it works is people decide to set aside resources they save, and then those are the resources that entrepreneurs can then use to undertake different production projects at different. Lengths and the length and the size of these projects is going to be determined by the supply of those resources and the critical balancing act is seen through interest rates you like you. Sort of See. That careful setting aside of resources for production and then entrepreneurs using it, you see that through the interest rates that emerge. The market but when the supply of credit is increased beyond real savings, then you get all of the distortions. So, I know I’ve been talking a while, but let me make one more point here though that business cycle is started when you have inflation as defined. By in our paper, however, if there’s an increase in the supply of gold with additional gold mining and the gold standard bringing market-selected money. That doesn’t start the business cycle, so that’s yet another reason why we wanted to draw a big clear line between this increase in the supply of money and this increase in the supply of money. One of them is inflationary, causes the business cycle. The other one is an increase in supply. Of money. But it’s. It’s through a typical market process.

Stephan Livera 00:24:11

Alright, so there’s a lot there. Let me just rewind or replay and summarize that for listeners. So, I think the basic insight here, as we said, there’s the Cantillon effect which is kind of the general effect of understanding that money is not neutral where you put it first matters and then a subset of that is the Misses effect which is. Essentially, based on his explanation of what we call Austrian business cycle theory, and that’s based on this idea that interest rates in the normal free market might be at a certain level, but actually with government intervention into the market for money and central banking lender of last resort, capital gains taxes, legal tender laws, implicit explicit bailout. Warranties, etcetera, they artificially shift the interest rates that entrepreneurs are able to get when they’re trying to get their projects or get funding. And so, then what happens is this process of malinvestment, meaning projects are undertaken or started or commenced, that cannot be seen to fruition because the resources required to complete them are not available because the I think in the literature it’s referred to as artificially lengthening the structure of production, right? But its people have sort of overreached in a way they thought they could undertake this project, but actually they couldn’t because the resource, the real resources required to undertake that project, whether they are physical or whether they are labor, they just weren’t available. And so that’s why, you know, that’s this process of Austrian business cycle theory and that’s kind of. Now, colloquial sense, where we see these bubbles being blown up and popped over time as a result of fear, money, and fractional reserve banking. How do you think that goes as a summary?

Jonathan Newman 00:25:48

That was an excellent summary. Thank you.

Stephan Livera 00:25:52

So, I think as yeah, so we’re talking about this idea that it’s. I think it’s also probably a good point to spell out here as well how much of this is an ethical or moral consideration versus how much of this is a value free economic consideration that even if we discarded the ethics component of it. But is there still this economics component that we can talk about and make a point about that? What do you think?

Jonathan Newman 00:26:17

Yeah, that that’s an excellent question. We, we tried really hard to be very clear in the paper that we are making a value free distinction here. So, we we’re just trying. To describe the different ways that the money supply can increase either through Fiat money. Through fiduciary media or through gold standard gold production in a gold standard. So, we look at all of these different ways that the money supply could increase and all of these different institutions and we just talk about how in in one set of cases there are these sorts of consequences in the market. Case in the example that we use most often in the paper is with the gold standard. There are different set of consequences and so that’s why we. Draw the line between this case and that case. As I’ve mentioned, however, you’re absolutely right, it is. It’s very yet you have to be really careful to not let ethical considerations creep in. I mean, I do think that there is a good way to bring in ethics. To talk about the ethics of money production like, like Holtzman does, you mentioned his name earlier, but we wanted to. We just, we wanted to make a distinction for the sake of economic theory, and economics is supposed to be a value free science where we’re looking at the world describing the way that it works. However, you’re absolutely right I so personally outside of me being an economist, I definitely think that like the Fiat money system that we’re under today is unethical. People, I think that the way the government uses Fiat money to as like a the surreptitious the subtle tax on everybody else. I don’t think that that’s a good thing to do. I think it violates all sorts of good ethical norms and values that I have. But in this paper. We really did try to just describe, we tried to be as objective as possible in saying here the economic consequences in this case and here are the economic consequences in this case. And here’s how they’re different.

Stephan Livera 00:28:20

Got it. So essentially the answer is in this paper it is value free like we’re explaining the problem of inflation in an economic sense, even disregarding the moral and ethical questions and concerns. Right. And I think this is probably an important thing to understand because sometimes people can conflate. So, you may be an Austrian economist, yes or no. You might be 1, or you might not be one, but you could also be a libertarian. You might not be a libertarian. Like the sort of the concepts, even though to be fair, many Austrian economists are also libertarian in their thinking. They’re not necessarily the same thing.

Jonathan Newman 00:28:53

One comment on that. So, I mean theoretically one could be an Austrian economist and you know hate or be a misanthrope. Just hate everybody and have you known, maybe terrible ethics or like a Very strange set. Of ethics that allows you to be mean to people or something. And in that case. As an Austrian economist who understands man economy and state in human action and all these big tones, and has done all the. Thing if you’re. If you’re like that, then. You could come to the conclusion that, well, yeah, of course we want fiduciary media of course, we want Fiat money because I want to hurt people. I want people out.  I don’t want Economic growth all. All those sorts of things. I know that’s sort of like a weird example, but that does highlight the. The step that you have to make to go from the value free to the to the policy prescriptions and the step that you have to take. Is you have to? You have to have a set of values. In there or. You have to have that set of values on. The way to. Say, well, we have these conclusions from just doing economics. Now how do I achieve my desired universe? Do I achieve the? My desired state of affairs in the world and in most cases. People are not misanthropes. They actually do care about their fellow man and what that means is Austrian economists do typically end up being libertarians because they’re gonna advocate for policies that are laissez-faire that. Of no or very low amounts of government intervention, and so and so. That’s why there’s that correlation. But I do think not just in Austrian economics, but in all schools of thought, a lot of people start to think the other way around where they start to, they say, well, I have this worldview I want to a lot of government, and therefore I’m gonna agree with this economic school of thought. Therefore, Keynesianism is good. Because I want a strong powerful. Government, but I mean the same sort of criticism. Could go the. So, like suppose you’re a good libertarian. So, if you started from libertarian principles and then decided, well, If I’m a libertarian, then obviously Austrian economics is correct. That’s also incorrect. You shouldn’t go that direction. So, you really should start with the objective science. Is describing the way the economy works, and then what that leads you to your value conclusions to your policy prescriptions.

Stephan Livera 00:31:21

I say yeah. And so, another interesting concept that might be good for you to help explain for us is this concept of the social rate of time preference. Because I think that’s also an interesting idea when we’re trying to distinguish between, you know, money creation of one kind versus money creation of another kind.

Jonathan Newman 00:31:40

So, time preference just refers to the way that we prefer present consumption. So, we all prefer the presence to the future just by our nature actually. So, the fact that we’re human and we exist in time, it means that any sort of delay in consumption. Means that we have to keep feeling that -sort of the discontent that we have with not having our intimate. I know I’m sort of getting all philosophy. But the idea is that we don’t like to wait. We don’t like to wait for our satisfactions to occur, and because of that we have. We had a positive rate of time preference. We’re gonna place a premium on the present and. It discounts on the future. So Rothbard talks a lot about this in the main economy and state, and so and so does misses. And human action. They talk about how the. The way that the market comes together, market participants come together with these different rates of time preferences Sense is it’s harmonious and its value productive. And the reason why is because there’s somebody who has a lot of resources but has a lower rate of time preference and there’s somebody who doesn’t have a lot of resources. But has a higher rate of time preference and. You know, needs to buy food, but. They don’t have don’t have the money. Today they can interact in credit markets. So, the person who has money. Available to lend they can according to their own time preference, they can lend the money and the people who want to borrow can borrow the money and we get. A market prices? The point being that we get this interest rate that balances the preferences of borrowers. Lenders Rothbart makes the important point that there’s an even more extensive and more important time market in the economy with production itself. So, if you think about factors of production as being something that’s not consumed today, but it’s something that we use to make consumption goods that we can enjoy tomorrow. It means that. All entrepreneurs, when they’re purchasing factors of production, they are delaying consumption as well. So, there’s the point is that there’s an interest rate that emerges in just production in general, not just in the low. And So, what we get is the social rate of time preference. So, the economy as whole settles. On the price in this market and we call it the interest rate in economic theory and of course there can be all sorts of differences in loan rates and rates of return in production. But the point is that there is this underlying. Rate that people are considering when they’re deciding on delaying consumption, so I’m not going to consume today and instead I’ll consume tomorrow.

Stephan Livera 00:34:13

Yeah. And I guess maybe it’s like a loose analogy, but it doesn’t exactly fit. But businessmen might evaluate projects based on what’s called IRR. Internal rate of return and so it’s sort of meant to reflect a little bit like they call it cost of capital. But as you said, that’s not the only type, but it’s kind of loosely reflecting. People are trying to reflect for that. Idea as well, because it’s kind of the idea of net present value of money as opposed to, you know, money from five years from now or whatever. And so, I guess with the creation of. So, I guess you know it all comes back to what we were saying. 

Around did you pay a cost for that new money, or did you just freely print it? And I think that sort of ends up being like the moral of the story or one of the morals of the story in terms of where you landed in terms of the, let’s say, the conclusion of this paper. And it also seems to me, as I read the paper. At least to me, it seems like fractional reserve banking is responsible for a lot of it. Like if we were to imagine hypothetically, we lived in a full reserve banking world and. You know whether it was a Fiat. For reserve banking. World or a gold banking for reserve world, or a Bitcoin for reserve world? You know how? How do you think that would impact our like the interest rates as an example, do you think for example, interest rates would be higher than they are today like on average just because it’s like the government is in the world today, the government is really suppressing those interest rates to give itself? You know cheap debt, right? So, you know, do you think we can reason that way or do you think it’s more like really it at the end of the day it still matters. What is the time? Preference of that society. Do you understand the question I’m getting?

Jonathan Newman 00:35:46

Yeah, I think so. The way I think about fractional reserve banking is that it’s another mechanism by which the central bank can’t influence the money supply, so it’s a very easy way for them to increase and decrease the supply of credit back in the day they would change reserve requirements that would have an effect on how much banks can lend. And this in turn would allow the Central Bank to have an influence on interest rates. Throughout the economy, so I know reserve requirements are zero now and they have a different setup where they’re paying interest on reserves and instead of enforcing, you have to keep a certain amount of reserves will reward you basically for keeping reserves and also they have other sorts of requirements like capital. The point is that the way I think about fractional reserve banking is that it’s basically a tool for the central bank these days to enact its own monetary policy. And well, while I do think that if. We had like. A full reserve system with a gold standard interest rates would like, on average would be higher. I’d also think that there would be less. So, what we have with the bank is interest rates go out of whack, so they go way down when they’re increasing the money supply and then once there’s some inflation they have to they have to pull back a time like in in the late 70s and 80s, they skyrocketed because Paul Volcker was trying to get the price inflation down. And I think we’re seeing a similar sort of thing. Here, but not to the same extent in. Terms of the. Effect on interest rates. So, I think we would have a more stable market and more stable economic environment, it would be easier for business to be conducted because there wouldn’t be these huge fluctuations in interest rates. And at the end of the day, the changes in the supply of money and the changes in. Interest rates would be something. That’s the result of the market. So, it’d be the result of people’s own preferences and deciding to increase the money supply through additional gold mining or even decrease the money supply in the form of like taking. Like melting down gold coins and turning it. Into a bracelet or something like that. All, all of that would be decided by market participants who have to pay attention to profit and. Loss and have. To you know, they have to provide for their families, so they’re making individually making all of these decisions to their own benefit. And the result is it’s a sum of beneficial choices. It’s a sum of choices that represents A socially beneficial arrangement. But as you said, in the case of a Fiat money, whether it’s full. Server fractional reserve the. Increases are not necessarily based on people’s demand for additional money. And in my view the fractional reserve system is just another mechanism by which you can have more exaggerated changes in interest rates and in the supply.

 Stephan Livera 00:38:37

Yeah, and it’s an important point. You make that even if, hypothetically, we lived in a full reserve Fiat system, but just the government gets to print more new coins. Well, we’re still gonna have inflation because, again, it’s an interventionist. It’s coming back to this idea of an interventionist phenomenon because they costlessly created more, and that would obviously still be harmful to us. As you said, even in a full reserve Fiat world, to be clear, we would still be suffering. Relative society would be suffered. In an overall sense, because governments can do that right. And of course, normally that’s towards the end stage, right, that’s more like the Venezuela, Zimbabwe level of inflation whereas you know, let’s say in most of the Western world, governments aren’t yet at the point where they’re directly printing all the money, they’re still, it’s still this. Fractional reserve system, where the commercial banks actually create most of the. The money and the central banks are, let’s say, backstopping them, acting as lender of last resort and just protecting this overall system that results in high inflation but not, you know, Zimbabwe level or Venezuela level, right?

Jonathan Newman 00:39:40

Right. I well, one extra thing that I’ll mention here is that I do think that in terms of the way the institutions have evolved, so we used to have we used, we used to just use coins, we used to use the precious metal coins and we would haul those around and then banks started issuing their bank notes that. And its I do think it started off as being a full reserve type system. And so, I think that step of depositing into a bank and then seeing the piece of paper that represents the coin. Just like any other sort of title. I think over time that that caused just a disconnect in people’s thinking of the paper is the money and not the gold that’s behind it. And I think with fractional reserve banking that that connection. Was lost even further. And then when governments started printing their own paper that was redeemable for gold. Of course, it was. Correctional as well. Then there was additional disconnect. It’s like now it’s not just that the paper is the money, but now it’s paper that’s provided by the government. And so, I think that’s how we evolve to the system that we have today where it’s just a pure paper. Fee money system.

Stephan Livera 00:41:49

Or we devolved, let’s say.

Jonathan Newman 00:40:50

So, I think that disconnect happened in stages. Like, it’s not like all of a sudden somebody had this great idea. I think. I think governments should be in charge of money and so let’s replace all of the gold or stop using gold and start using green pieces of paper with president faces on it. So, it’s not like somebody just all of a sudden made that decision it was a slow evolution. Maybe a devolution is a better term a slow change and where the government realized that it could use. This piece of paper as a way to expropriate from the economy.

Stephan Livera 00:41:26

Right. Yeah. I think it is. I think most of you know you, me and probably most of my listeners would agree it’s a devolution of money unfortunately. And I’m also curious whether, OK, so you know where we are today. We’re talking about what we think inflation should be defined as, right? It’s more like a, it’s an interventionist phenomenon we’re as we’re talking about it, but if you talk to you know, Joe 6 pack average guy on the street, if you talk to him about inflation, he’s probably thinking of CPI inflation, right? And so, the average person, or even maybe even financial commentators, might be thinking of it like that. They’re saying, really what they mean is CPI inflation. But I’m curious as well are people are sort of buying into a Keynesian? Brain, when we say when people say this colloquial. Idea of they need to raise the interest rates like they’re saying the central bank should raise the interest rates to get inflation down. Isn’t that sort of a Keynesian frame to even think about it?

Jonathan Newman 00:42:20

Yeah, I think you’re right. I’m not even sure that we can win. This battle is especially not with just, you know, one paper in the Quarterly Journal of Austrian Economics. Well, I think that we were sort of targeting our paper at economists who. Were in Austrian circles who? We’re talking about inflation and we’re just trying to make sure. That we all see the distinction between. This type of inflation and money supply increase and this money supply increase. That’s on the market, so. I yeah, I don’t. I’m not sure that we can rescue the term. I’m not sure. That we can. You know, get that back at least, maybe not. In my lifetime. But the point is we just want. We just wanted people to think more clearly about what inflation is and the consequences there. You’re absolutely right that it is. It’s a Keynesian idea to say that if we just sort of tinker with this interest rate, tinker with this price over here, then we can have this sort of result on prices. But as we all know. It’s a lot of smoke and mirrors. They don’t understand all of the unintended consequences of their policy prescriptions. They don’t understand how complex the economy is. They don’t understand how sometimes you could. You could attempt to do one thing and have them. Opposite. Sort of consequence. But I mean that that happens when you have this Keynesian view that’s looking at these big aggregates and defining inflation as the change in the CPI.

Stephan Livera 00:43:46

OK. So yeah, we’ve spoken about a lot of things. Let’s try to summarize some of the key points here. So, I guess we would say, you know, going back to how we started these is defined inflation as this increase in money supply associated with the increase in the demand for money, Rothbard defined it more like. In issuing money beyond the stock of specie, in this example, issuing gold tickets, more paper claims more than the actual amount of gold, or in a Bitcoin case, more Bitcoin tickets than there are actual Bitcoin held on reserve. And so, the, I guess the moral of the story, the lesson of this paper is to try to explain the different ways money could be produced. The Cantillon effect, as that happens. And to sort of point out that the actual negative consequences are when somebody is making money and didn’t pay a cost for it. I would say that’s probably. The summary right.

Jonathan Newman 00:44:35

Yeah, that’s exactly right. We really were not trying to launch a war over words. We’re not trying to have a semantic battle. We just said that we in our view the term inflation is most suitable for this case, but the main point of the paper was to simply distinguish between those cases. You’re exactly right.

Stephan Livera 00:44:55 

So, what do you think our, I mean, just kind of more broadly about Austrian economics and economics education? I’m curious, what are your thoughts more broadly on that? Like do we have, what are our hopes for success on trying to reach people because you know I think maybe there are sometimes there’s like pop econ books and they can sort of help get to people. As an example, and then other times it’s just, you know you’re maybe you’re calling out only to a small percentage. You know, maybe you know 100% of the population won’t. Will not read or understand this. But maybe you’re just sort of your narrow casting. You’re trying to just get to those people because that’s realistically all you can reach. What are your views just on East Australian economics and trying to spread that more generally?

Jonathan Newman 00:45:37

So, I’m generally optimistic. I think that there are some things that are happening that caused me to be optimistic. I mean 11. Huge thing is just the existence of Bitcoin itself, so that has caused tons and tons of people to start reading Austrian economics and start and start thinking about. Time preference and the effect of. Of fractions of banking and the sort of the negative consequences of Fiat money. So that’s a huge reason, at least from like a larger view. Why I’m optimistic is that there’s it seems like there are way more people now that are skeptical of the monetary institutions that we have today compared to, I don’t know. Like 15 years ago.

Stephan Livera 00:46:20

Yeah, for sure.

Jonathan Newman 00:46:21

So, it seems like we’re moving the needle and of course, only time will tell what actually happens, but I am optimistic. You also I. I think that really since. The 2016 time period when we had Trump and we had Brexit, I think that even outside of just Bitcoin circles, I think we have more people who are willing to be skeptical of government in general. They’re willing to be skeptical of international bodies that are trying to. Impose their own will on what? On what’s going on in their own country. So, you see a lot of decentralization. Efforts you see a lot of people who aren’t trusting the media as much as they were before. And so, I think those sorts of things are really great. It’s a really great thing. To see this happening, it’s because people aren’t taking the media at its word, and they’re and they’re being skeptical of what they’re hearing from government officials. In terms of like in, in just Austrian circles, I know a lot of. People like to. To recommend like we need to do more popular books and popular articles and that sort of thing. And some people say, like, no, we need more scholarly work and journal articles and big books that are for academics. And I mean, I know it’s sort of a cop out to say this and I’m just thinking like, why don’t we do both? Like, if you’re good at doing the popular stuff, do that if you think. That there’s a good hole. That you could fill in the academic literature then. Go forward and. So, I’m not one to make a sort of a like a broad blanket statement that everybody needs to. Be emphasizing this type of work versus that type. Of work I. Know we’re talking about a paper that Christopher Hansen and I have published in the Quarterly Journal of Austrian Economics. But you know, I also write for and I’ve got other popular works as well. And Christopher does other things as well. I think the point is, you know find the most suitable way and the most productive way for you to fit yourself into the movement and go for it as opposed to trying to say everybody needs to be doing this sort of thing.

Stephan Livera 00:48:27

Gotcha. Yeah, and I think. To the point you were making about normalization of various terms, I’ll make that as an example, right. I would say 15 years ago, even 10 years ago, if you said the term Fiat money, most people would be like, hey, what’s that? Whereas nowadays I think more and more people are actually starting to understand. OK. For our money, it’s government money, right? Like, so we’re making some progress. I think you know, even for me when I was teaching people about stuff, you know, 10 years ago, I’d get that question be like, hey, what’s that money? Right. And so, then I have to kind of be OK, wait. Normal people don’t know what that means. I have to, you know. So, we’re making some progress, I think. But you know it’s uneven and there are times where we regress, right? I think the years 2020-2021 and 2022 were sadly a very big loss of liberty for, let’s say, billions of people around the world. But hopefully we can reach some people out there. So, look, I think that’s probably a good spot to wrap up there. Something where can people find you online or keep up with your work?

Jonathan Newman 00:49:25

So, I’m active on Twitter. My username is at Newman, J underscore R and you can also see articles that I’ve written at for the Mises Institute at in and I just want to say thank you so much for having me on let. Me also just. Make sure Christopher. Has articles on he. He’s does a ton of great work. He’s a great scholar. It’s unfortunate that he wasn’t able. To join us. Today, but I do recommend everybody. Check him out as well.

Stephan Livera 00:49:58

And I’ll hope to get Christopher on at some point as well in the future. So, Jonathan, thank you for joining me. It’s been an enjoyable chat. Thank you.

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