David R. Henderson  

Paul vs. Paul

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Let the Spinning Begin... Unrealist Foreign Policy...

If you had asked me how I would have expected Ron Paul to do in debating Paul Krugman, I would have said that Krugman would score a TKO. He would rack up points in each round and dominate. This isn't because I agree with Krugman. But I do think he's a brilliant economist. Ron Paul, on the other hand, although I think he's a smart man and I think his heart and most of the policies he advocates are in the right place, often speaks way too fast and jumps from point to point without making a coherent case. And his economics are pretty much completely self-taught. (In class on Tuesday, when the debate came up in my 5-minute discussion, I said, in front of an audience of 16 males, "Ron Paul is a gynecologist and he's self-taught." The class roared with laughter. Then I got it.)

But I thought it was close to a draw. You can see the video and a partial transcript (it misses a lot) here. I won't analyze line by line, but I will point out where I thought Ron Paul was good and where I thought he was off, and ditto with Paul Krugman.

Managing an economy
Ron Paul started by saying that he doesn't want the government to manage the economy, whether through central planning or through monetary policy. He said, "This idea that somebody or some group might know what the proper amount of money might be or what the proper rate of interest should be is sort of presumptuous." I agree and I think he was strong here. Interestingly, it took Jon Stewart on The Daily Show to ask Alan Greenspan, when he was pushing his book a few years ago, to ask him, basically, if you don't want government to plan the economy, why do you think government can plan the money supply. Economists who advocate government monetary policy are asked that question all too rarely.

Where I thought he erred is in equating fixing the rate of interest, which he called, correctly, "price fixing," with wage and price controls. But with wage and price controls, you get shortages or surpluses. With government trying to set interest rates, you're likely to get the wrong interest rate, but it will be a market-clearing interest rate because the Fed reserve is entering the market only as a supplier or demander of credit, not as a price fixer in the narrower sense of that term.

Krugman, by the way, could have pointed out that he is not an advocate of wage and price controls (other than the price of unskilled labor and the price of medical care), but he didn't. Maybe Krugman's ""I'm not a defender of the economic policies of the Emperor Diocletion, let's make that clear" was his way of saying that.

Volatility and the Great Depression
Krugman said, "History tells us that in fact a completely unmanaged economy is subject to extreme volatility, subject to extreme downturns. I know this legend that some people like that the Great Depression was somehow caused by the government or the Federal Reserve, but that's not true. The reality is it was a market economy run amok, which happens repeatedly..."

But he seems to have forgotten Christina Romer's work (here, which she summarized in The Concise Encyclopedia of Economics as follows:

In some recent research, I have tried to avoid the problem of inconsistent data by comparing the crude prewar statistics with equally crude postwar statistics. That is, I have compared the existing prewar series with modern data that are constructed using the same assumptions and data fragments that were used to piece together the prewar series. These comparisons show essentially no decline in the severity of cycles between the prewar and postwar eras. They also show little change in the duration and frequency of cycles over time. Thus, much of our apparent success at eliminating the business cycle seems to be a figment of the data.

Inflation
There's a sense of proportion missing in Ron Paul's comments. Yes, inflation, in a tax system that is unindexed, does reduce the incentive to save. I'm not sure if that's what he was saying. But a 2% inflation rate is a small hit. I know that Ron Paul's favored inflation statistics are from John Williams at Shadowstats. I find Williams not credible. After I briefed Ron Paul and 7 other Congressmen in 2007 on my study, "Do We Need to Go to War for Oil?," I had some one-on-one time with him in which I tried to persuade him that Williams is not credible: I didn't succeed.

The 1950s
Krugman said, "We had policies that fostered a strong middle-class instead of using the worship of the supposedly ideal force of the market." This reflects Krugman's strange view that times were better when a split-level house and a trip to Europe were incredible luxuries. I kid you not, as that 1950s person, Jack Paar, used to say. Here's Krugman in an article in 2002:

Those considered very well off lived in split-levels, had a housecleaner come in once a week and took summer vacations in Europe.

Post-World War II
Ron Paul said, "After World War II, a lot of the debt was liquidated. But guess what else we did? Troops were coming home. 10 million people were coming home. Big government liberals wanted to have job programs. They weren't put into place. We cut spending by some 60%, we slashed taxes. Finally, the Depression ended. So, it was that liquidation of debt that made it available that we could come back to work again."

He did great until the "slashed taxes" part. The post-World War II U.S. economy is Exhibit A against the Keynesian view that you can't cut government by a lot without throwing the economy into recession. I think Ron Paul had my study in mind or studies by Robert Higgs that I drew from in doing mine. But he was wrong on taxes.

The Helicopter Drop
Krugman said, "When Ben Bernanke was talking about the helicopter, he was taking that from Milton Friedman. That was really his idea."

That's true. I wouldn't have expected that to be much of an argument against Ron Paul, though, because Ron Paul was never a Friedmanite in that sense. But then Ron Paul surprised me, in a negative way. He said, "Why did the Federal Reserve bail out the rich and not give the money to the mortgage holders? If you care about poor people...Why didn't you use helicopters and pass it back to the home builders? That would be more fair."

I have stated elsewhere that there's a huge difference between the Fed buying assets and giving money away.

Currency competition
Here's the issue on which I think Ron Paul beat Paul Krugman. Ron Paul started by saying that he doesn't want to end the Fed in the short run but simply wants to subject it to competition. He said, "Just allow me to legalize the currency, get rid of the monopoly, take the taxes off gold and silver and get rid of the sales tax and capital gains tax -- don't hide behind a monopoly. People today if they use gold and silver, you can go to jail."

Here's what monetary economist Lawrence H. White said in testimony about a bill to legalize currency competition:

Section 3 of the Act rules out federal or state taxes on precious-metal coins, whether minted by a foreign government or by a private firm. This section would allow precious-metal coins to compete with the US Treasury's token coins (made of base metals, and denominated in fiat US dollars) without tax disadvantages (sales taxes on acquisition and capital gains taxes on holding, from which Federal Reserve Notes are exempt), and thereby a level playing field for competition among monetary standards.

White's whole testimony is worth reading if you want to know more of the background on currency competition.

Krugman replied, ""That's not my understanding of the law. But do you really think people use dollar bills because the federal government isn't allowing them to use other stuff? That seems like a very strange point of view...You can do barter with all kinds of stuff..."

But Krugman didn't say what his understanding of the law is. It's possible that he doesn't know the law. Notice also that he brings barter into it. That's a reach: there are many possibilities for money that are neither Fed Reserve notes nor barter.

Printing Money and Fraud
Here I think Ron Paul went way overboard and Krugman won. There is nothing fraudulent per se about printing money. There is nothing fraudulent about causing business cycles. It may be bad policy but it's not clearly fraudulent.

Debt to GDP Ratio
Krugman said, "[I]f it takes another 30 points [DRH note: that's almost $5 trillion more of federal debt] to get us out of this depression, I'm willing to accept that. I'm not going to claim there's no risk, but the risk of not doing what it takes to get out of a depression is a clear and present danger. I don't want us to go up to Japanese levels of debt, even though they turn out to be able to carry those levels of debt. But we're not anywhere close to a red line here, is the point. I can't give you a specific number."
How close we are to the red line is a judgment call, of course. But those like me who think Keynesian policy is a bust and the post-World War II U.S. experience can actually teach us something will think that Krugman failed.


Comments and Sharing


CATEGORIES: Monetary Policy



COMMENTS (51 to date)
J.D. writes:

Your quote of Romer is truncated toward the end. Something with the page coding?

David writes:

I'm neither an economist nor an OB/GYN, self-taught or otherwise. Can someone refer me to a moral defense of gov't. debt for the purpose of juicing a present day's economy at the expense of the future? Keynes' aphorism that in the long run we're all dead and Krugman's more recent argument that debt is just what members of future generations will owe to each other through the agency of gov't. strike me as sophistry that perhaps comes more easily to those (like Keynes and Krugman) who are wealthy and well-connected, but childless and thus have a different stake in the future. I suspect Dr. Paul has a better handle on the moral question of gov't. debt burden than his more sophisticated debate opponent.

David R. Henderson writes:

@J.D.,
Thanks. Fixed.

David R. Henderson writes:

@David,
Keynes' aphorism that in the long run we're all dead and Krugman's more recent argument that debt is just what members of future generations will owe to each other through the agency of gov't. strike me as sophistry that perhaps comes more easily to those (like Keynes and Krugman) who are wealthy and well-connected, but childless and thus have a different stake in the future. I suspect Dr. Paul has a better handle on the moral question of gov't. debt burden than his more sophisticated debate opponent.
I agree with you about Krugman’s sophistry. Your take that neither Keynes nor Krugman cared much about future debt because one was, and the other is, childless, is interesting. I’ll have to think about it. The context, though, in which Keynes made his point about the long run was different. Keynes was challenging the view--that he cleverly linked to the classicals, mistakenly lumping virtually all his predecessors with the classicals--that everything’s fine because wages will adjust downward and we will get the long-run full-employment equilibrium. By saying “In the long run, we are all dead,” he was saying that that’s too long to wait to get to full employment. My own hunch--but it’s just that--is that Keynes would have been appalled by the current level of federal debt.
On the moral question of debt burden, I think you’re right about Paul v. Paul.

J.D. writes:

I laughed when Krugman mentioned barter. Barter doesn't use money, so it isn't relevant to any discussion about how a money system operates other than explaining a pre-money proto-economy.

As to Krugman stating that Paul's point was not how Krugman understood the law to operate: I guess Krugman hasn't heard of Bernard von Nothaus and Liberty Dollar?

PrometheeFeu writes:

I think Paul's comments on inflation are more than out of proportion. I think he confuses inflation shocks with inflation trends. The redistribution from savers to lenders happens only in the case of unexpected inflation shocks. As long as inflation remains on track, the expectation will be built in the investment rate of return.

Brad Warbiany writes:

J.D.,

As a libertarian, a Ron Paul fan, and a supporter of alternate currencies, I was originally well predisposed to support von Nothaus & the ALD. There was always something about it, though, that didn't quite sit right... After reading the seizure warrant back in 2007, I figured it out:

http://www.thelibertypapers.org/2007/11/16/the-liberty-dollar-seizure/

Alternate currencies can't be spent at par with FRN's. They need to have a floating exchange rate. This is inconvenient for alternate currencies, of course, but misrepresenting the ALD as something that can be spent "on par" with FRN is IMHO bad practice and borderline fraudulent. And the "move-up" process is designed to always keep ALD undervalued compared to FRN, so it can always be spent "at a profit". A true alternative currency doesn't need to have a "move-up" process as the floating exchange rate accounts for relative movement between the asset prices.

I want to support the ALD, but I have significant concerns that it was marketed as an "alternative currency" out of one side of their mouth, but fraudulently marketed as a par-value replacement out of the other.

Thomas Boyle writes:

A competing currency was used in Brazil as a quite clever, and very effective way to end inflation - although in this case it was the government itself that introduced the competing currency.

Look up "Plano Real". In essence, the government required people to post prices in legal tender and in a new non-physical currency, the Real (I don't know if the pun in English was intentional). The government published the exchange rate to be used daily. Prices in the legal tender kept rising, while Real-denominated prices were quite stable. After a while, people started to think, trade and negotiate in Reals, then convert to legal tender for the transaction. One weekend the government re-denominated bank deposits to Reals, and in the morning the old inflationary currency was gone.

Fascinating history! And suggestive of the potential value of competing currencies. But the US Constitution reserves to Congress the right to coin money and regulate its value...

Simon writes:

From the introduction of your linked study:

While government spending fell like a stone, federal tax revenues fell only a little, from a peak of $44.4 billion in 1945 to $39.7 billion in 1947 and $41.4 billion in 1948. In other words, from peak to trough, tax revenues fell by only $4.7 billion, or 10.6 percent. Yet, the economy boomed.

Sounds like a tax cut to me?

J.D. writes:

@Brad:

They didn't get him for that. They convicted him under this: http://www.law.cornell.edu/uscode/text/18/486.

[link fixed--Econlib Ed.]

Steve Roth writes:

The 50s: "Krugman's strange view that times were better when..."

This failure to distinguish between prosperity and prosperity *growth* (the latter being what Krugman talked about, the former being what you choose to talk about) is so egregious, from one who knows the difference perfectly well, that it can only be seen as an intentionally specious argument.

Let's Be Free writes:

Paul Krugman is an outstanding statistician, an excellent mathematician and a lousy economist. Ron Paul is a real doctor who understands real economics. Ron Paul knows that that separating the medium of exchange and the money supply from the economic value chain inevitably results in bubbles that burst with resulting seriously adverse economic contractions. Ron Paul won a unanimous decision.

David P writes:

If you had said Ron Paul was a self-taught musician or computer programmer nobody would laugh. I see why it's easy to think it's absurd though.

Also wouldn't Adam Smith be considered a self-taught economist?

Saturos writes:
Yes, inflation, in a tax system that is unindexed, does reduce the incentive to save. I'm not sure if that's what he was saying

He might have been talking about the fact that nominal interest rates don't rise one for one with inflation, due to the Mundell-Tobin effect. OTOH, he may have just been speaking from a generalized notion that inflation reduces the value of your savings.

Saturos writes:
If you had said Ron Paul was a self-taught musician or computer programmer nobody would laugh. I see why it's easy to think it's absurd though.

The difference is between performing an activity and studying the universe.

Henry writes:

How did Krugman end up debating Paul and not Murphy, who has the pledge drive going on? Is Krugman's desire for a more well-known (and easier) opponent worth more than tens of thousands for charity?

mick writes:

Don't be intimidated by a Nobel for professional liberalism. Krugman's IQ and economic expertise are grossly overrated. Why don't you ask how Ron Paul got 400% on the recession markets? Or is that to dirty?

David R. Henderson writes:

@David P,
You missed the joke.

David Henderson Author Profile Page writes:

Actually, Steve, the article I quoted from was not about growth; it was about inequality.

Jonathon Hunt writes:

@ Henderson

The childless comment seems to be taken from Hoppe's controversy. If I recall correctly, Hoppe said that Keynes did not care about future debt due to him being a homosexual. His argument was that homosexuals have a shorter time preference due their tendency to not have a child.

VangelV writes:

I am sorry but it seems to me that John Williams is a lot more credible than the BLS. The simple fact is that if the same methodology that is used today is applied to the data from the 1970s the inflation rate of the 1970s would come out to be much lower. The same is true of unemployment. Sorry David but I just don't see how you could have thought that the debate was even close. It is clear that Krugman has no idea what Dr. Paul was talking about because he is actually ignorant of what Austrian Economics really says. The first thing he should do is try to educate himself. A good place to start would be figuring out what monetary competition really means.

Jim Glass writes:

As to Krugman stating that Paul's point was not how Krugman understood the law to operate

Apparently lots of people don't understand how the law operates.

It is perfectly legal to create your own alternative currency and circulate it in the USA. The Fed even has a free publication on the subject, "Private Money, Everything Old is New Again" that explains the rules and gives illustrations of operating examples. Private monies have circulated in the USA since 1789 and still do. You are as free to use them as you are to use euros, yen, or anything else.

The challenge is getting other people to use one with you. Why would I use Ithaca Hours or Bitcoin when my ATM card works so well with dollars?

I guess Krugman hasn't heard of Bernard von Nothaus and Liberty Dollar?

Ah, now what is illegal is calling your own private money "dollars" and passing them off as such. That's fraud. You can see why the govt would get upset about that. I mean, if you came up with your own new soft drink and started selling it as "Coke", how long would *that* last?

Here is video of von Nothaus repeatedly doing exactly that.

He walks up to vendors to make a purchase with his own-made money, the vendor asks "What's that?", and he says "It's the new ten dollar coin". The vendor goes "OK", and von Nothaus gets the goods plus change and walks away gloating about how easy it is.

Result: Von N gets the goods, and the vendor who relied upon his lie gets stuck with non-money that his/her suppliers won't take, and the loss.

That is fraud, f-r-a-u-d. He deserved to be convicted and belongs in jail.

Jim Glass writes:

I am sorry but it seems to me that John Williams is a lot more credible than the BLS. The simple fact is that if the same methodology that is used today is applied to the data from the 1970s the inflation rate of the 1970s would come out to be much lower.

1) The Billion Prices Project uses an entirely new and independent methodology, and confirms the BLS numbers.

2) We know the nominal dollar amount of GDP and its rate of growth. If inflation is much higher than reported then, by arithmetic, real GDP growth must be much lower -- negative even. If that were so we'd still be losing hundreds of thousands of jobs, and would have been all the time since 2008, we'd be in Great Depression II for real.

The high inflation claims just don't add up right, literally.

Jim writes:

I do not understand the argument that intentional inflation, say 2%, is not a big deal; the compounding effect alone is horrendous.

Structurally, it is terribly regressive and a clear transfer from poor to institutions and capital intensive organizations with any pricing power.

In fact the right to print and devalue the currency structurally ensures that banks and the government will eventually subsume a large portion of the economy (especially when they are bailed out). Its baked in.

I cannot speak for Mr. Paul, but I would say that given its structural issues, it is immoral, and I can see why he is so emotional about it. Please help me understand where I am wrong.

A writes:

David, can you please expand on your opinion that Shadowstats is unreliable? I came across the site last week and thought it was interesting, but haven't looked much further.

Soonerliberty writes:

Jim Glass,

It may be perfectly legal to use or create private money according to certain rules, but the problem, as anyone who supports free money would tell you, is that taxes are collected in dollars and alternative sources of money (gold, silver) are taxed. Bad currency (fiat) drives out good currency (free) as a result. Plus, businesses must accept US dollars even if they don't want to. If legal tender laws were repealed, it would be more accurate to say that anyone can create money. The legal tender laws make competition with the US dollar effectively impossible, so it's not as simple as saying it's hard to get others to use your money. Clearly, in the past, people did prefer alternative currencies to paper currencies. Think, "Not worth a greenback." The question is what changed that: legal tender laws.

As far as Nothaus is concerned, it's clear he broke the law. The only question is whether such a law should exist. You are right that "the new dollar" is ambiguous. Was it fraud? Hard to say if we don't know the intent. If he intended to deceive, then yes. If he merely wished to get a new dollar in circulation, that is not fraud. It would be the only case in history I know of where the defrauded actually gained from the fraud by having a coin that appreciated instead of depreciating.

In any case, we know the Fed has a monopoly. Why not end it? Then we could see what people really prefer.

Joe Cushing writes:

The 1950s was the era of the bungalow now the split level. Maybe he's right about well off living in split levels. If he is, there weren't many who were well off. If you see a split level, chances are very strong it was built in the 60s or 70s. For those tho don't remember a bungalow is a 1 1/2 story home where the up stairs is usually one room with slanted ceilings. Split levels are much nicer and they came later.

I don't get the relevance of pointing out Paul is self taught. Are you saying that because he is self taught, he doesn't know the topic well?

Jim

The reason steady inflation of 2% doesn't hurt is because the economy can plan for it. Interest rates take steady inflation into account. Asset prices rise with the inflation. So nobody loses 2% of their wealth each year. The only wealth that is lost by the people is in two places: the loss of the value of paper bills and coins held by people and capital gains taxes on unreal gains. The first is minor sense very little of our wealth--even low income people's wealth--is in bills and coin. The second is a tax.

David R. Henderson writes:

A writes,
David, can you please expand on your opinion that Shadowstats is unreliable? I came across the site last week and thought it was interesting, but haven't looked much further.
Yes. I did so here: “Brett Arends on CPI."

David P writes:
@David P, You missed the joke.

Haha yes I did.

Jim writes:

Joe Cushing writes:

The reason steady inflation of 2% doesn't hurt is because the economy can plan for it. Interest rates take steady inflation into account. Asset prices rise with the inflation. So nobody loses 2% of their wealth each year.

Theoretically, this argument sounds logical. But rising asset prices are incredibly regressive. In a saner world, they would be slowly depreciating.

And in reality, firms with broad brand elasticity do plan for it, and take advantage of it to raise real prices. Especially on the lower bound, rising living costs outstrip productivity induced wage increases, especially given that artificially manufactured oligopolies in education and health care have been driving the economic bus and crowding out real wage increases for decades now.

Besides, we are forced to take the whole package; inflation, rising public service costs, and an artificially lower interest rate. All these policies are born of the same master, and they are regressive and a direct income transfer. Let's face it; most of our regulation and monetary policy protects established capital and existent income streams. Then we cry because of growing inequality.

I still believe economists under-estimate the distortion of inflation as well as how beneficial to the economic organism supply side deflation would be.

VangelV writes:

"1) The Billion Prices Project uses an entirely new and independent methodology, and confirms the BLS numbers."

It uses internet prices. Only people who don't go to supermarkets, fill up their own cars, don't pay for insurance, health care, or tuition believe that nonsense.

My point remains the same. If we use the same methodology as we did in the 1970s the current inflation rate would be reported to be around 8-10%. If we use the current methodology and apply it to the 1970s data we get 4-5% or so.

"2) We know the nominal dollar amount of GDP and its rate of growth. If inflation is much higher than reported then, by arithmetic, real GDP growth must be much lower -- negative even. If that were so we'd still be losing hundreds of thousands of jobs, and would have been all the time since 2008, we'd be in Great Depression II for real."

First of all, you have been losing hundreds of thousands of jobs. But, thanks to the methodological changes implemented by the BLS, discouraged workers not looking for jobs are no longer counted. Measure unemployment the same way as we did under Carter and you are looking at more than 20%. That is not exactly a sign of a healthy economy.

John David Galt writes:

The post-World War II U.S. economy is Exhibit A against the Keynesian view that you can't cut government by a lot without throwing the economy into recession.

When was government cut by a lot? I had the impression that the WW2 level of defense spending continued through the entire Cold War, even before JFK added the space program and LBJ added Medicare.

J.D. writes:

@Jim Glass; @ SoonerLiberty:

I think you both are mistaken.

Read the statute I linked to above. It prohibits any person whom government has not authorized from making and issuing any metal coin intended to be used as money, even if it looks nothing like government currency of any country and is of original design.

Essentially, it criminalizes infringing on governments' authority to coin money. It says nothing about calling your private currency "dollars." Further, "Coke" is a registered trademark; "dollar" is not.

Neither does the other statutes upon which they convicted von NotHaus (18 USC 485, or the conspiracy statute). That one prohibits making coins or bars that resemble U.S. currency.

They pegged him on the 485 because the Liberty Dollar looked too much like government coin (which is such a subjective standard that a competent judge would have thrown it out for vagueness), not because he intended to defraud anyone (he was quite honest about what he was doing).

They nailed him on 486 just for violating the government monopoly by making and selling the Liberty Dollar coins. That shouldn't be a crime at all.

As to telling the vendor "it's the new 10 dollar silver piece," (i.e., what he actually says in the video, and not what you misrepresented it as; who's behaving fraudulently now?) interpreting it as a fraudulent claim requires a few assumptions on your part that you aren't entitled to make. As said above, the U.S. has no trademark on the word "dollar." I could get a newly minted silver 10AUD Australian coin, pass it to a U.S. vendor, make the descriptive statement that "it's the new 10 dollar coin," and not have misrepresented anything. There's even less reason to believe any misrepresentation is taking place when he calls it a "silver piece" and not a "coin."

What else is noteworthy is that the vendor he gave it to noticed right away that it was different from government currency. Hard to say it subjectively resembles U.S. money when a vendor who routinely handles cash spotted it right away...

I think there's a great shortcoming in thought in this country about exchanges. We all understand that we buy things things with money. And we're often held to "caveat emptor" in our dealings. But think about the flip-side of the same exchange. The retailer or vendor is buying money and paying for that money with goods or services. If I hand you the coin, and make a descriptive statement about it, and you make your own false assumptions about what that descriptive statement means, it's your mistake that becomes the problem; nothing about my behavior was "criminal." Caveat emptor.

Now each side has a duty to disclose, but nothing about a silver piece makes it inherently lack "merchantable quality." It can easily be sold to any silversmith or precious metals dealer.

So, please try and explain again how von NotHaus defrauded anyone.

David R. Henderson writes:

@John David Galt,
When was government cut by a lot? I had the impression that the WW2 level of defense spending continued through the entire Cold War, even before JFK added the space program and LBJ added Medicare.
Read my study.

Costard writes:

Joe - "The reason steady inflation of 2% doesn't hurt is because the economy can plan for it."

When plans change, the structure of the economy also changes. The absence of deflation over a long period of time will facilitate the accumulation of debt, first of all because the threat of deflation and the reality of liquidation is no longer acting as constraint, and secondly because asset inflation tends to outpace price inflation. This also means that the economy is skewed to the advantage of those who can enter the debt market most cheaply -- meaning the wealthy.

J.D. - I believe the relevant point here is that given a low rate of inflation, small transaction costs imposed upon private currency by the government are effectively prohibitory. I'm not that familiar with the specific taxes that apply, but if for instance every transaction involves a capital gains element - if the dollar's devaluation is treated as appreciation in the private currency, and taxed - then a private currency becomes unwieldy to use, and effectively requires a closed system. The most effective way to get rid of something is not to outlaw it, but to make it uneconomic.

Steve Roth - I'm not satisfied with David's answer, either, but it's no worse than Krugman's caricaturization of history. A debate in economics should focus on what we can know, not what we can imply by cherry-picking a correlation out of a distant past romanticized in sitcoms.

Jim Glass writes:

Jim Glass, It may be perfectly legal to use or create private money according to certain rules, but the problem, as anyone who supports free money would tell you, is that taxes are collected in dollars and alternative sources of money (gold, silver) are taxed.

Ah, well, so when did it become a logical necessity for private money to a tool for tax evasion? Though, yes, this is what many of the paleo-libertarian schemes boil down to. But it is hardly necessary.

There have been hundreds of legal "private monies" in the USA. My favorite was the "Constant" which was based on a basket of commodities to maintain a steady real value. It circulated in New England during the inflationary 1970s, and steadily gained in value versus the dollar to become so popular that regional banks provided checking and savings accounts in Constants. With no problem at all from the govt or IRS. The Constant closed down only because the operator behind it went into his old age, didn't have the funds to expand backing of it, and couldn't find a successor.

See, it is possible to have a popular commodity-based private money that isn't an attempt at tax fraud.

Though if I had a lot of gold/silver that I could turn tax-free by declaring it my own private money I'd probably prefer that, eh? :-)

Plus, businesses must accept US dollars even if they don't want to.

That is totally false. No seller is required to take dollars in a sale if it wants to be paid in something else -- euros, yen, Ithaca hours, Quatloos, gold, land or whatever. That is entirely a matter of agreement (contract) between the parties.

If legal tender laws were repealed, it would be more accurate to say that anyone can create money.

The legal tender law in the USA absolutely does not require a seller to accept dollars in any sale.

The purpose of the legal tender law was to make USA "greenback" paper money legal satisfaction for dollar-denominated debts that had been payable in gold dollars prior to the US's leaving the gold standard during the Civil War. Specifically, pre-Civil War US bonds that were required to be redeemed gold dollars. The legal tender law enabled the govt to pay them off in greenbacks. That is the entire purpose of the legal tender law. See the Supreme Court's "Legal Tender Cases".

The law in no way bars transactions legally payable in other currencies. Think about it: billions-worth of currency transactions payable in other currencies close in the USA every day. If the parties owing payment in the other currencies suddenly found a legal right to renege and pay in dollars instead, the international currency markets would collapse.

Purchase/sales and debt agreements are matters of contract between the parties. The legal tender law does not affect them at all. If a party contracts to make a payment in Ithaca Hours, that payment is due in Ithaca Hours and the courts will enforce it as such.

If you want to go into business as a retailer or lender accepting only Bitcoin or Ithaca Hours or your own New Constant as payment from your customers, there is nothing at all in the law stopping you. Only a lack of customers will stop you.

soonerliberty writes:

Jim,

It seems you are correct about the US law, but that's also true in Germany where I am, which I was referring to. I should've made that clear. For example, in Germany there is a de facto and de jure concept that if citizens start using too many alternative monies, then the state can shut them down even though they allow contracts in other currencies. The same was true when Roosevelt confiscated gold. Perhaps, that and the taxes on gold and silver cause the de facto monopoly. Section 31 U.S.C. 5103, entitled "Legal tender," which states: "United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes, and dues." Because citizens must pay taxes in US dollars, people hold on to more dollars than otherwise. Or do you think that's irrelevant?

Or do you believe it's the "full faith and credit" that lends the currency credence?

Greg Jaxon writes:

Both missed the boat on Debt to GDP

The debt to GDP ratio (bad though that is) can't tell us how far gone we are (or have yet to go).
As Melchior Palyi and Antal Fekete point out it is the marginal productivity of new debt that decides whether the country benefits from new borrowing. Though as a non-economist I'm unsure how (or even whether) this can be measured. [What time lag applies between loan and GDP effect?...]

Dr. Paul could have demolished Krugman's point in 5 seconds and sealed his autodidact economist creds if he'd pulled that term out of his vast store of knowledge in time, saying "it's subjective" left the impression that we could maybe vote on it and come out OK either way.

Bob Murphy writes:

David, are you just objecting to the term "slash" instead of "reduce"? The top marginal income tax rate went from 94% in 1945 to 91% in 1946 (I think).

That might not sound like much at first, but actually it means out of the marginal $100 earned above $200,000, before a person kept $6 and now he gets to keep $9. So that's a 50% increase in after-tax earnings. That could have an enormous effect, if you think incentives matter for high-productivity people. Presumably a lot of investors switched out of tax-exempt assets and into stuff that was more productive physically.

David R. Henderson writes:

@Bob Murphy,
David, are you just objecting to the term "slash" instead of "reduce"? The top marginal income tax rate went from 94% in 1945 to 91% in 1946 (I think).
Yes. I thought “slash” too extreme. Re marginal incentives, you’re absolutely right.

Steve writes:

Are there any countries that use competing currencies today? It would seem if using competing currencies is such a great idea that any country that adopted it would rapidly outperform the others. A little research says Zimbabwe has adopted this strategy so I expect they will be an economic powerhouse shortly. Sorry to be facetious but you guys need to come back to Earth on this stuff.

soonerliberty writes:

"Are there any countries that don't have slavery today? It would seem if not having slavery is such a great idea that any country that abolished it would rapidly outperform the others. A little research says Britain has adopted this strategy (1833) so I expect they will be an economic powerhouse shortly. Sorry to be facetious but you guys need to come back to Earth on this stuff."

Same statement in early 1800s.

The world has competing fiat currencies.

Evan writes:
There's a sense of proportion missing in Ron Paul's comments. Yes, inflation, in a tax system that is unindexed, does reduce the incentive to save. I'm not sure if that's what he was saying. But a 2% inflation rate is a small hit.
That doesn't surprise me. People tend to develop passion about issues that is not in proportion to how objectively important those issues are on a global or national scale. It's just human nature. Probably a glitch from having evolved in a tribal environment.
Steve writes:

@soonerliberty

Trying to figure out if you are agreeing or disagreeing with me. The feeling on this thread is that Krugman got beaten by Paul over his feelings on competing currencies (the US is on the wrong track by using a central bank). Yet as you note we already do have competing currencies at the global level. How do we reconcile this?

Your slavery example is telling. It equates a moral issue with economics. It seems most people who oppose a central bank are doing it on moral grounds rather than any economic reasoning (do people really want to be carrying around multiple currencies to do business?).

soonerliberty writes:

Steve,

I'm against the central bank for moral and economic reasons.

1) I think the moral reason is clear. It is difficult to justify the central bank monopoly. It is also difficult to justify the wealth transfers it unleashes. And the bailouts only add to that pile, but that has been an ongoing thing.

2) Actually, my slavery example was both moral and economic. At that time, it was impossible to see the economic effects of banning slavery. I doubt I need to make the moral argument why slavery is bad.

3) Throughout history, people did use varying currencies. Today, it would be even easier with technological improvements. I also believe the market would tend toward a few currencies as it did in the past or at least a few standards. I have no idea what they would be. Cigarettes in concentration camps, seashells, etc. I'm not big on gold. I would just let the market decide. One problem, however, is we've devalued the dollar so much, it would have to be done slowly over time to avoid terrible monetary contractions.

My only purpose is to take away the perverse incentives the central banks unleash.

You're quite right that it is unrealistic at the moment, but that is not a good argument. One could've used the same logic to counter many new ideas: Galileo, Darwin, separating Church and State, and the list goes on. The fact that no one does something does not mean it's a bad idea. It does make it suspicious, but it doesn't invalidate it. There could be reasons states are reluctant to free currency (how to pay for war, social state, etc?).

The Germans I talk to talk openly of leaving the Euro and the EU. That would've seemed impossible 5 years ago, but things change. That's my only point.

Steve writes:

soonerliberty,

Thanks for the thoughtful answer. Believe it or not I like both Pauls for different reasons. And I do agree with you that just because something has become the standard does not mean it is right.

My opinion is Krugman is being cut down for being a pragmatist. Getting rid of the Fed is not politically viable right now. He appears to be getting criticized for not properly putting down an impossible idea.

Henry Clay writes:

You are mistaken about Printing money not being fraud.

Printing money debases the currency, and robs those who can't print money of their purchasing power, even moreso because of what you said, David Henderson, because of the taxes on gold, silver, and other "barterables" - which robs from the value of those goods versus the Paper, fiat currency.

John Seiler writes:

Time Magazine, Nov. 12, 1945: "The deepest surgery ever practiced on U.S. taxes—the slicing off of $5.9 billion—was completed without fuss or flowers. For what once would have been considered a miracle of scalpel work, Congress engaged in a minimum of consultations beforehand, a minimum of self-congratulation afterward. The taxpayer, though assured the operation had been a success, felt hardly better at all."

"For businessmen, the 1946 tax cuts will provide $3,136,000,000 of relief by eliminating all excess-profits taxes, by reducing corporation income-tax rates by 2 to 4%. This will give industry a cushion against the rising pressure between price ceilings and labor's wage..."

Forbes, April 22, 2011: "Some tax cuts followed the end of the war in 1945, but they were relatively minor. In the Revenue Act of 1945 the excess profits tax was repealed, the top income tax rate fell to 86.45% from 94%, and the corporate tax rate fell to 38% from 40%."

Actually, the top income tax rate cut amounted to an 8% cut of the total amount. Not bad. But it's also crucial to point out that this signaled an end to the New Deal era of tax increases and anti-business assaults. And it occurred under a Democratic president, Truman, and a Democratic Congress. As Adam Smith said, uncertainty about taxes is worse than high taxes. The tax cuts provided certainty of more pro-business tax and other policies.

John Seiler writes:

The April 22,2011 Forbes article also said: "The Revenue Act of 1948 reduced individual income tax rates by another 5% to 13%, and increased the personal exemption."

So there were TWO tax cuts in the period Ron Paul mentioned: 1946 and 1948. Significant.

Sayan writes:

Dear Mr. David Henderson,

Good analysis, but let me bring points as follow:

1) I don't understand why you think Ron Paul "did great until the "slashed taxes" part"? It appears from your study, that this did help indeed in recovering the economy.

2) Ron Paul calls money printing fraudulent, because it's money creation without any backing from the this air. Ron Paul is absolutely right, because this process dilutes purchasing power of orginal holders in favour of the first recipients of new money.

3)Infaltion is not the CPI it is inflation of money supply. I think it is higher anyway, if you count gas and food prices. But inflation in countries, like Kazakhstan, is much higher just becuase of US dollar money printing, and it does steal our wealth and in wealth of other countries too!

4)Being self-taught Ron Paul understands economics better than many formarly educated.

I think my points above support that notion and that you are not entirely correct in the analysis of the debate!

Brent Thomas Davis writes:

Fractional reserve banking is fraudulent for two reasons. First, fractional reserve banking is fraudulent because it causes prices to artificially rise, meaning that more work has to be done in exchange for goods and services than would be otherwise. Part of the market value of their labor is stolen. In spite of what people agree to, and most are completely ignorant of the multiplier effects of fractional reserve banking, when people accept bank notes for their gold deposits they do so thinking that their gold can be redeemed at any time and that no additional receipts would be printed and loaned out that are not backed by deposits. When bankers print up deposit receipts in excess of actual deposits, thereby increasing the number of notes in circulation beyond those backed 100% in the bank, prices are bid up just as they would be by adding base metal to pure gold coins, artificially increasing the coins in circulation. Increasing bank notes beyond those strictly assigned to legitimate deposits always causes the value of the notes (money) to be reduced by the law of supply and demand through bidding up prices denominated in the currency, and so the person who makes the legitimate deposit is defrauded of part of the purchasing power of his money just as the person who is given a coin that is impure is defrauded of part of the pure value of his coin. Even if he later trades his bad coin for a pure one of the same denomination he will have paid for goods in fraudulently inflated prices. Second, there is the fraud of misrepresentation. To have the notes accepted on par with the real notes they must say that they are redeemable in gold as well, and this cannot be true for all fractional reserve notes at any one point in time: this is why we have runs on banks and bank bankrupcies. These are esoteric points yet true. The amount of fraud is so small in the individual units that it is hardly noticed by the depositor, but over time it adds up and makes the patient rich fabulously rich, over time, and the poor poorer. Increased productivity and reduced transaction costs also mask these effects but recognizing the multiplier effect demonstrates that this effect is not benign. Getting to be the first to trade in the new money before prices rise is like always gettin a few % discount on everything you buy as well as first mover bonus in the market. Since those who get the money first deal in such large quantities, small percentages add up for them.

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