A Response to Frances Coppola’s Claim I “…know f#@% all about monetary economics.”

A certain graph from a recent blog by Frances Coppola was brought to my attention. After some thought I realized this particular section of her writing offers the general reader an ability to come to an understanding about the two main competing ideologies in economics and why neither can perfectly fit bitcoin into their argument such that the general reader might grant one side victory over the other.

I have previously used the terms Rothbardian and Keynesian and what is most important is that we outline and understand what defines each side so we might be able to understand why their views have historically been unresolveable.

In regard to the Keynesian perspective I should like to invoke the Nashian definition:

…let us define “Keynesian” to be descriptive of a “school of thought” that originated at the time of the devaluations of the pound and the dollar in the early 30’s of the 20th century. Then, more specifically, a “Keynesian” would favor the existence of a “manipulative” state establishment of central bank and treasury which would continuously seek to achieve “economic welfare” objectives with comparatively little regard for the long term reputation of the national currency.

In other words the Keynesian view is that the central bank should manage the economy by controlling the supply of money. From this definition Frances’ Keynesian admission lies in this quote from the section titled: ‘What conclusions can we draw from this section’:

It is surely better to allow M to adjust so that prices remain stable, than to keep M fixed and allow prices to swing wildly — which is what generally happened when the UK was on a gold standard

The “surely” is the key word here. There is no real justification from her as far as I read, rather is it simply the implied goal of a Keynesian (in contrast to what we will define as a Rothbardian) to want to control the general price trend of the national economy.

The Rotherbardian view, in contrast, seeks to remove political intervention in the money supply, such that the prices reflect only the supply and demand of the respective commodities being observed. By maintaining a certain peg to a commodity such as gold, arbitrary government (central bank) sponsored supply increases or decreases in the money supply are removed which in turn removes political noise from the price signals of the commodities.

The Rothbardian or Austrian view believes these politically free price signals allow us to optimally distribute our commodities

Frances suggests that Mises shares her ideal:

Even for Austrian economists, price stability is the real concern. Mises wanted to restrict money creation because he thought it was the only way of ensuring price stability

I have not fully studied Mises, or perfectly Rotherbardian or Austrian economics, but I have to think that any Austrian economist would be appalled at the suggestion that stabilizing prices is their goal.

To demonstrate this we can go to mises.org and find a paper on this very subject. One section labeled “Why the policy of price stability leads to more instability”:

In short, there is a total separation between changes in the relative prices of goods and the changes in the price level. So it seems that the only problem with inflation is that it obscures the visibility in the movements of relative prices of goods thereby causing a misallocation of resources. Other than that inflation is harmless. So if one could somehow make changes in the price level stable and predictable one would be able to neutralize the negative effect of inflation.

The problem with this way of thinking is that it ignores the fact that in a market economy the relative prices of goods and services cannot be established independently of money. Prices of goods are determined by the demand and supply of these goods and by the demand and supply of money. Hence, changes in money supply cannot be neutral as far as relative prices of goods are concerned.

The first paragraph explains what the Austrian would feel is the beginning Keynesian folly and the second paragraph explains the beginning of the difficulty from the Austrian view. Changes in the money supply change the reliability of the price signal to effectively show the supply and demand of the commodities they price:

Now, the effect of changes in the demand and supply of money and the demand and supply of goods on prices of goods is intertwined and there is no way that one can somehow isolate these effects. Thus it was observed that over a time span of one year the price of tomatoes increased by 10% while the price of potatoes went up by 2%. This information, however, cannot tell us how much of the increase in prices was due to changes in demand and supply for goods and how much on account of changes in the demand and supply for money.

According to Rothbard, “Even if all the prices in the array had risen we would not know by how much the PPM (purchasing power of money) had fallen, and we would not know how much of the change was due to an increase in the demand for money and how much to changes in stocks.”3

The essay drives the point home and clearly contrasts the Coppelean/Keynesian view:

Since it is not possible to isolate the monetary effect on individual prices of goods, obviously then the whole idea that one can measure and somehow stabilize the price level is preposterous.

I mentioned a possible scenario to Frances that involved such a removal of the money supply induced price changes and as I understand her response (I am trying to keep her in context and would allow her to refute if she felt otherwise) is that there is no benefit since any money supply induced price changes would be reflected in the international exchange rate of the currency.

For example, in a world where only one money exists, and could exist, a change in the price of a commodity from one location to another would be a reflect of supply demand rather than local government control of the supply of money (since no one controls the supply locally in such a world).

In a world of floating currencies like today. If a commodity’s price in country A is declining versus the same commodity’s price in country B we need to look at the exchange price trend of the currencies to the respective economies. If the exchange price of the currencies is stable this indicates differing supply demand trends.

So in this sense Frances is correct such a removal of the political intervention in the money supply is not very important as a quick calculation could factor in the trend of the exchange prices.

However, this is where our definition of Keynesian comes to mind:

…would continuously seek to achieve “economic welfare” objectives with comparatively little regard for the long term reputation of the national currency

Such a view, that we can count on the exchange prices of the currencies, in order to factor in the effects of politically induced inflation is not an observation of the long term international “reputation” (purchasing power trend) of a currency.

To understand this, think about two nation’s currencies that are perfectly stable and each with stable prices form a domestic view. Are these currency’s purchasing power stable? It depends perhaps on a broader view, or a comparison to a large basket of currencies etc.

In this we arrive at an understanding of why a division exists in economic philosophy. In effect, the Keynesians are shorterm local thinkers and the Austrians are long term international thinkers. The shorterm is an easy sell in times of economic duress. Most people want to attribute the Keynesian central banking methods to intentional malice and slavery through taxation. But in Canada for example, we recently allowed the international valuation of our dollar to decline with the price of oil and nobody complained-the population felt this was quite agreeable as the relative gain in exports seemingly offsets the loss in oil price revenue for the short term.

It is a short term fix and easy sell to the “voters” but at the expensive of an otherwise higher pay-off that could be achieved if the world could adopt a different kind of money standard which I mean to describe by the end of this writing

Here it is relevant to note that our definition of Keynesian does not specifically refer to Keynes. I have previously noted Keynes proposed a bancor which was effectively an evolution of the gold standard-an international settlement unit, apolitical in nature, that would provide liquidity among nations.

Frances told me she is not in line with Keynes on a particular aspect and my guess is that it is this aspect. It is quite strange to note that a “Keynesian” by our definition ends up not inline with Keynes, but I think Keynes did have the worlds greater interest in mind and that his observations and proposal were not implemented in a way that achieved that result.

These are the differing views and why the Rothbardians or Austrians feel that price stability is an absurd endeavor.

This suggests the bitcoin maximalist view as an ultimately finitely supplied money has credibility, however, there is proper contention that is often thrown at bitcoin and/or Nash’s proposal for Ideal Money: national and central banks won’t just adopt such a system out of altruism. If bitcoin is to replace all central banks and central banked money then this would be greatly contested by the existing structure.

But the Keynesian argument is slightly more nuanced. To not be able to enact monetary policy takes away the Keynesian’s greatest weapon. In times of crisis they cannot use their tools to spur the economy. A necessary trade-off for greater longer term prosperity so say the Austrians but this is not an outlook that can be sold “politically”.

This is where we need to understand the difference between ‘ideal money’ and “Ideal Money”.

The former we can find our definition from the Keynesian view that holds the idea that money supply should be elastic and that its supply can be optimized to serve its demand. To increase the supply with demand and decrease the supply if demand wanes is the function of the central bank and this is an attempt to mange the ideal money supply.

This isn’t completely unreasonable from the Austrian view or at least the free banking view-it’s just that they believe that it’s an impossible feat as there is no proper metric that will allow for ideal supply management. Central banks use a local price index to determine the inflation of their domestic currency, but the CPI is only a best guess and something that is constantly reweighted over time-it is thought by the Austrians to be a metric and method that is far from being removed of political intervention.

George Selgin suggests we might move from a CPI method to a production factor based method thus changing the metric for observation. He feels this would be a more accurate predictor of what the optimal money supply should be from a central banking perspective.

To understand “Ideal Money” we need to understand that we are thinking from a different perspective and therefore asking a different question. We can think from the Satoshian view as someone about to release an otherwise apolitical and international currency unto the world.

The question of “optimal” supply then is not necessarily one of an elastic choice. When a nation devalues their currency from an international perspective this is because of the competitive relationship to other nation’s economies. It is not necessarily the same problem the issuer of a global currency faces.

It is true from a central banking perspective one would expect an elastically supplied currency that fluctuates with supply and demand. But in thinking about removing the political signals in the prices a world of one currency only doesn’t have this problem of “optimal supply’. If bitcoin were adopted universally then the Austrians would get their way.

But the Keynesians can play a role here too and this might speak to the unwillingness of the legacy system to allow such a scenario as mentioned above to play out.

In order to understand this alternative path to “Ideal Money” we have to return to the problem of evaluating the purchasing power of a local currency with respect to other floating currencies. This was the usefulness of gold, whether or not a certain currency was actually even pegged to it, gold’s supply has been said to be relatively predictable and so at certain times we might have felt the value of gold should be somewhat stable and that changes in prices could be understood with respect to it.

Gold, however, is not perfect in this regard. Its supply isn’t perfectly finite as it is subject to geopolitical and technology advances.

We can perhaps mitigate this limitation or “singular-ness” by considering an array of commodity prices that might be considered more geopolitically stable. Although this might not be politically achievable it is still an observation of a possibly “globally” used metric that could be observed to understand the changes in prices around the world in respect to the currencies of nations.

There is still then the problem of technology-imagine a miracle energy source is found and what effects this might have on the stability of such an index.

This is why bitcoin is so significant with respect to Nash’s concept of an industrial consumption price index (an international cpi). The available mining locations of bitcoin is effectively anywhere there is internet (ie geopolitically decentralized) and more importantly a miracle discovery in energy, that would cause an influx in mining power, would be offset by the difficulty adjustment algorithm that regulates speed at which a bitcoin is mined.

That is to say, if we value a type of international gold standard then we can see that bitcoin is like super -gold for this specific purpose.

From a Keynesian view bitcoin is not ‘ideal money’; from the Nashian view bitcoin is a possible precursor to Ideal Money which effectively means to have the world on a single apolitical international standard.

What is missing is a hypothetical scenario where hyperbitcoinization takes place and the purchasing power of bitcoin begins increase, eventually pushing the purchasing power of state money down as the citizenry rejects ‘inflationary’ state currencies (if currencies aren’t comparatively inflationary then we are already in a scenario of Ideal Money).

Perhaps, it is not a likely scenario from the Keynesian view, but usually they are far quicker to jump on the next suggestion…that in such a world central banks COULD choose policies such that the purchasing power of their money is stable with respect to bitcoin’s hyper-inflationary purchasing power trend.

This suggestion usually immediately sets off alarm bells with many groups but also especially Keynesians. They will say a central bank would never do this and could never achieve it anyways.

But the observation is that in this scenario bitcoin would be serving as a crisis hedge especially versus a run on inferior state money. If the state money were to suddenly adopt a policy of ‘increasing the purchasing power over time’ the significance and value of bitcoin as a crisis hedge would be reduced.

The ultimate asymptotic result of this change in policy, assuming other central banks would also act in self preservation, would put the world on a perfectly apolitical monetary basis but without taking away the central banking role of controlling the money supply (simply moving the metric from the local cpi to what would effectively be an international ICPI).

The equilibrium between all of the money would be effectively a secular deflationary trend, perhaps with many currencies, but all functioning on the same value trend.

The argument here is that because we can understand bitcoin absolutely could and should play this role it is a self-fulfilling prophecy that it will. This provides a utility for bitcoin that is not directly related to its usefulness as a medium of exchange (ie coffee money) which is often the argument from people as to why it cannot be adopted as money. To serve as an apolitical basis for international comparison of the trend of national currencies’ purchasing power, bitcoin’s base layer does not need to scale up its transaction capacity, increase the speed, nor to lessen the cost of making a transaction.

Put another way, bitcoin is not ideal money, it’s better gold than gold. It is this limitation that allows it to exist and this observation that allows us to understand that Satoshi’s blunder in creating a less then ideal currency is actually Nash’s genius.