the dollar will always be important
The use of money released mankind from close dependence on nature and local markets; but, in facilitating a high degree of specialization and exchange, money has caused individuals to rely on the entrepreneurial success of others. Yet, even those normal hazards of business and trading relationships can be exacerbated by an untrustworthy monetary system. Price signals - the means by which diverse activity is coordinated - are corrupted by monetary disturbances. The nature and detail of that disruption is the focus of monetary economics, where a primary requirement is to identify ideal conditions whereby economic coordination may best be achieved.
Related Results
The influence of money is described as "neutral," when it neither impedes nor enhances activity in real sectors of the economy. With neutrality, markets and money are analogous to engines and lubricating oil. The fundamentals of free exchange or engineering can be explained in the absence of money or lubricating oil, but the practicalities remain. Neutral money, like a frictionless engine, provides a conceptual benchmark. It is an abstraction, the conditions for which can "never be given in the real world." So, there is no corresponding stratagem: no "maxim which is immediately applicable to the practical problems of monetary policy" (Hayek, 1935, p. 129). The concept of neutral money is simply an enabling device to reach a greater depth of understanding of the essential problems of the money economy.
In practice, money cannot be neutral. Not least for the fact that it does not exist in a pure form,(1) the presence of money necessarily intrudes on the circumstances of real resources allocation and exchange. Whether in the context of classical economics or that of more recent macroeconomics, many of the economic "bads" that are associated with business cycles and international payments disequilibria originate in monetary disturbances. Yet, the explanations that are provided by classical theory are very different from those of Keynes' General Theory. So, it is necessary to exercise judgment on their respective plausibility.
Related Results
The influence of money is described as "neutral," when it neither impedes nor enhances activity in real sectors of the economy. With neutrality, markets and money are analogous to engines and lubricating oil. The fundamentals of free exchange or engineering can be explained in the absence of money or lubricating oil, but the practicalities remain. Neutral money, like a frictionless engine, provides a conceptual benchmark. It is an abstraction, the conditions for which can "never be given in the real world." So, there is no corresponding stratagem: no "maxim which is immediately applicable to the practical problems of monetary policy" (Hayek, 1935, p. 129). The concept of neutral money is simply an enabling device to reach a greater depth of understanding of the essential problems of the money economy.
In practice, money cannot be neutral. Not least for the fact that it does not exist in a pure form,(1) the presence of money necessarily intrudes on the circumstances of real resources allocation and exchange. Whether in the context of classical economics or that of more recent macroeconomics, many of the economic "bads" that are associated with business cycles and international payments disequilibria originate in monetary disturbances. Yet, the explanations that are provided by classical theory are very different from those of Keynes' General Theory. So, it is necessary to exercise judgment on their respective plausibility.
With the denunciation of mercantilism, the goal of economic activity was reformulated: wealth accumulation by the state was superseded by the satisfaction of individuals' wants. The latter would not be served by the accumulation of export surpluses. Furthermore, the impartial and spontaneous mechanisms (encompassed by Adam Smith's "invisible hand"), were the secure means by which independent economic action was coordinated. By the market mechanism of continuous price adjustments, demand and supply were moved toward harmony. Although unexpected developments were endemic, personal incentives motivated and informed speculative entrepreneurship. Through active and competitive bidding, entrepreneurs drove money prices toward a mutually consistent configuration. There was no claim to optimality. Rather, the system of market price adjustments offered a practical arrangement for the production and distribution of wealth across an extended economic order.
Related Results
Yet, in addressing the issue of the consequences (for market price signals) of monetary disturbances, the classical paradigm was developed far beyond Say's Law. The expectation that money would be neutral was plausibly argued to hold for the long run; but what of the more immediate consequences for economic activity, of changes in the volume of money in circulation?
IKeynes expressed his dissatisfaction with the central concept of the loanable funds theory; that is, the natural rate of interest. By the argument that for every shift in demand (for funds to finance investment expenditures) there are corresponding shifts in levels of national income and savings, Keynes introduced the paradox of thrift, the multiplier process, and the conclusion that the natural rate "had nothing very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo" (Keynes, 1936, p. 243). He suggested the existence of many different natural rates of interest, each one corresponding to a unique level of (un)employment equilibrium. Keynes' argument was that an expansion of investment (demand for loanable funds) raises production, so that incomes and savings (supply of loanable funds) also rise; and if shifts in demand cause shifts in supply, there is no determinate theory of price (interest rate). Demand and supply in the market for credit was irrelevant and the loanable funds theory defunct!
Related Results
According to Keynes, the interest rate is set by the choice of portfolio assets. A highly liquid asset (money) bears zero (or a relatively low) yield and is held only on the speculative expectation that the prices of bonds (and other financial securities) are more likely to fall (incurring a capital loss to holders) than to rise. The balance of speculation in financial markets determined the optimum quanta of holdings of money and less liquid securities. The thesis is that the rate of interest is determined by transactions between those (selling bonds) who feel that bond prices were more likely to fall and those (buying bonds) who feel that bond prices were more likely to rise.
The speculation that bond prices might rise (or fall) is identical with the speculation that the rate of interest might fall (or rise) and provides the substance behind Keynes' musing that, "[i]t is interesting that the stability of the system and its sensitiveness to changes in the quantity of money should be so dependent on the existence of a variety of opinion about what is uncertain. Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ" (Keynes, 1936, p. 172). Keynes believed that by adjusting the relative volumes of money and bonds in circulation, the authorities could manipulate the money price and yield of bonds. Interest rates could be set by action that would alter the weight of opinion as to whether bond prices were more likely to fall or rise. The objection that his analysis was deficient in that it did not say how the interest rate would be determined in the absence or uniformity of specific thoughts as to future bond prices was largely ignored.(6) There is always (in Keynes' terminology) a speculative demand to hold money from individuals who are speculating on a rise in the rate of interest. Moreover, Keynes' curious explanation for the inapplicability of this "liquidity preference theory of interest rate determination" to the United States - "where everyone tends to hold the same opinion at the same time" (Keynes, 1936, p. 172) - attracted little comment.
Keynes' crucial idea, that monetary expansion would dissipate its force in financial markets (on the price of bonds), rather than in markets generally - "[t]he primary effect of a change in the quantity of money . . . is through its influence on the rate of interest" (Keynes, 1936, p. 298) - necessitated the abandonment of a second plank of classical economics: the quantity theory of money. Here, Keynes argued that, "an increase in the quantity of money will have no effect whatever on prices, so long as there is any unemployment . . . whilst as soon as full employment is reached, it will be the wage unit and prices which will increase in exact proportion to the increase in effective demand" (Keynes, 1936, p. 295), and "[s]o long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money" (Keynes, 1936, p. 296). Keynes showed no concern that his new liquidity preference theory was exposed to the same criticism as that which he leveled against the loanable funds theory: at full employment, it has "nothing very useful or significant to contribute" because an expansion of money supply raises prices, which raises the transaction's demand for money; and if a shift in supply causes a shift in demand, the theory is indeterminate.
Related Results
The intellectual force of Dennis Robertson's early and persistent criticisms of Keynes' liquidity preference theory is substantial and acknowledged more readily than erstwhile (see, for example, Bridel, 1987, pp. 170-81; Fletcher, 1987). Indeed, Keynes' own claims were modest enough, "[t]he resulting theory, whether right or wrong, is exceedingly simple - namely that the rate of interest on a loan . . . equalises the attraction of holding idle cash and of holding the loan. It would be true to say that this does not carry us very far" (Keynes, cited from Bridel, 1987, p. 171) but he knew that his new principle of effective demand would be invalid in the presence of the long-established loanable funds theory. With the latter, there is no income multiplier, no principle of effective demand, no paradox of thrift and no macroeconomic explanation of unemployment.
Related Results
Yet, in addressing the issue of the consequences (for market price signals) of monetary disturbances, the classical paradigm was developed far beyond Say's Law. The expectation that money would be neutral was plausibly argued to hold for the long run; but what of the more immediate consequences for economic activity, of changes in the volume of money in circulation?
IKeynes expressed his dissatisfaction with the central concept of the loanable funds theory; that is, the natural rate of interest. By the argument that for every shift in demand (for funds to finance investment expenditures) there are corresponding shifts in levels of national income and savings, Keynes introduced the paradox of thrift, the multiplier process, and the conclusion that the natural rate "had nothing very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo" (Keynes, 1936, p. 243). He suggested the existence of many different natural rates of interest, each one corresponding to a unique level of (un)employment equilibrium. Keynes' argument was that an expansion of investment (demand for loanable funds) raises production, so that incomes and savings (supply of loanable funds) also rise; and if shifts in demand cause shifts in supply, there is no determinate theory of price (interest rate). Demand and supply in the market for credit was irrelevant and the loanable funds theory defunct!
Related Results
According to Keynes, the interest rate is set by the choice of portfolio assets. A highly liquid asset (money) bears zero (or a relatively low) yield and is held only on the speculative expectation that the prices of bonds (and other financial securities) are more likely to fall (incurring a capital loss to holders) than to rise. The balance of speculation in financial markets determined the optimum quanta of holdings of money and less liquid securities. The thesis is that the rate of interest is determined by transactions between those (selling bonds) who feel that bond prices were more likely to fall and those (buying bonds) who feel that bond prices were more likely to rise.
The speculation that bond prices might rise (or fall) is identical with the speculation that the rate of interest might fall (or rise) and provides the substance behind Keynes' musing that, "[i]t is interesting that the stability of the system and its sensitiveness to changes in the quantity of money should be so dependent on the existence of a variety of opinion about what is uncertain. Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ" (Keynes, 1936, p. 172). Keynes believed that by adjusting the relative volumes of money and bonds in circulation, the authorities could manipulate the money price and yield of bonds. Interest rates could be set by action that would alter the weight of opinion as to whether bond prices were more likely to fall or rise. The objection that his analysis was deficient in that it did not say how the interest rate would be determined in the absence or uniformity of specific thoughts as to future bond prices was largely ignored.(6) There is always (in Keynes' terminology) a speculative demand to hold money from individuals who are speculating on a rise in the rate of interest. Moreover, Keynes' curious explanation for the inapplicability of this "liquidity preference theory of interest rate determination" to the United States - "where everyone tends to hold the same opinion at the same time" (Keynes, 1936, p. 172) - attracted little comment.
Keynes' crucial idea, that monetary expansion would dissipate its force in financial markets (on the price of bonds), rather than in markets generally - "[t]he primary effect of a change in the quantity of money . . . is through its influence on the rate of interest" (Keynes, 1936, p. 298) - necessitated the abandonment of a second plank of classical economics: the quantity theory of money. Here, Keynes argued that, "an increase in the quantity of money will have no effect whatever on prices, so long as there is any unemployment . . . whilst as soon as full employment is reached, it will be the wage unit and prices which will increase in exact proportion to the increase in effective demand" (Keynes, 1936, p. 295), and "[s]o long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money" (Keynes, 1936, p. 296). Keynes showed no concern that his new liquidity preference theory was exposed to the same criticism as that which he leveled against the loanable funds theory: at full employment, it has "nothing very useful or significant to contribute" because an expansion of money supply raises prices, which raises the transaction's demand for money; and if a shift in supply causes a shift in demand, the theory is indeterminate.
Related Results
The intellectual force of Dennis Robertson's early and persistent criticisms of Keynes' liquidity preference theory is substantial and acknowledged more readily than erstwhile (see, for example, Bridel, 1987, pp. 170-81; Fletcher, 1987). Indeed, Keynes' own claims were modest enough, "[t]he resulting theory, whether right or wrong, is exceedingly simple - namely that the rate of interest on a loan . . . equalises the attraction of holding idle cash and of holding the loan. It would be true to say that this does not carry us very far" (Keynes, cited from Bridel, 1987, p. 171) but he knew that his new principle of effective demand would be invalid in the presence of the long-established loanable funds theory. With the latter, there is no income multiplier, no principle of effective demand, no paradox of thrift and no macroeconomic explanation of unemployment.
Keynes' View of Mercantilism
Keynes' criticisms of Say's Law were focused on the proposition (which Keynes took to be Say's Law) that competition tends always to cause output to expand to the point of full resource utilization: [t]hus, Say's law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment" (Keynes, 1936, p. 26). Indeed, the whole purpose of Keynes' General Theory was to propagate the idea that market forces do not necessarily sustain a full employment level of output; and, once Keynes had targeted Say's Law, it is consistent that he should have discovered merit in mercantilism.
Related Results
That there is an "element of scientific truth" in the mercantilist doctrine followed from the proposition of The General Theory that the interest rate and the level of investment did not self-adjust to levels compatible with full employment. So arose the necessity to eliminate the interest rate as the mechanism that channeled saving via the market for loanable funds, to meet a demand for investment goods. With the liquidity preference interest rate theory, an excessive speculative demand to hold money (or "high liquidity preference") set a high interest rate, and a low level of investment expenditure. It was then possible to regard aggregate demand as deficient, in the sense that it would be opportune if some means could be established to increase investment expenditure.
In an international context, variations in the money supply (and, according to Keynes' analysis, variations in the interest rate) were largely dependent on the balance of payments, from which derived the "avowedly national advantages" of the mercantilist doctrine. A trade surplus boosts the domestic circulation of money. Yet, because mercantilism was unashamedly a beggar-my-neighbor approach, it also gave a tendency to drift into war, which was a serious flaw! Keynes argued that the mercantilists had recognized the nature of these problems but had been unable "to push their analysis to the point of solving it." The solution that had been missed was that of applying "the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment program directed to an optimal level of domestic development (Keynes, 1936, p. 349).
An economy with chronic unemployment faces two problems: it is short of remunerative investment opportunities at home and it requires the means to bring down the domestic rate of interest. The mercantilist objective - a trade surplus - gave a remedy in three parts: overseas markets brought enhanced returns on investment; foreign currency earnings offered the means to finance overseas investment; and, by adding to the domestic circulation, overseas earnings exerted pressure on domestic interest rates.
For all of these reasons, the mercantilist preoccupation with the trade balance was not (as classical economics had insisted) "little better than nonsense." Unlike the mercantilist zero-sum game of trade balances, the option of an autonomous domestic interest rate was open to all, so that all countries can contribute to the quite remarkable result of "restoring economic health and
Keynes' criticisms of Say's Law were focused on the proposition (which Keynes took to be Say's Law) that competition tends always to cause output to expand to the point of full resource utilization: [t]hus, Say's law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment" (Keynes, 1936, p. 26). Indeed, the whole purpose of Keynes' General Theory was to propagate the idea that market forces do not necessarily sustain a full employment level of output; and, once Keynes had targeted Say's Law, it is consistent that he should have discovered merit in mercantilism.
Related Results
That there is an "element of scientific truth" in the mercantilist doctrine followed from the proposition of The General Theory that the interest rate and the level of investment did not self-adjust to levels compatible with full employment. So arose the necessity to eliminate the interest rate as the mechanism that channeled saving via the market for loanable funds, to meet a demand for investment goods. With the liquidity preference interest rate theory, an excessive speculative demand to hold money (or "high liquidity preference") set a high interest rate, and a low level of investment expenditure. It was then possible to regard aggregate demand as deficient, in the sense that it would be opportune if some means could be established to increase investment expenditure.
In an international context, variations in the money supply (and, according to Keynes' analysis, variations in the interest rate) were largely dependent on the balance of payments, from which derived the "avowedly national advantages" of the mercantilist doctrine. A trade surplus boosts the domestic circulation of money. Yet, because mercantilism was unashamedly a beggar-my-neighbor approach, it also gave a tendency to drift into war, which was a serious flaw! Keynes argued that the mercantilists had recognized the nature of these problems but had been unable "to push their analysis to the point of solving it." The solution that had been missed was that of applying "the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment program directed to an optimal level of domestic development (Keynes, 1936, p. 349).
An economy with chronic unemployment faces two problems: it is short of remunerative investment opportunities at home and it requires the means to bring down the domestic rate of interest. The mercantilist objective - a trade surplus - gave a remedy in three parts: overseas markets brought enhanced returns on investment; foreign currency earnings offered the means to finance overseas investment; and, by adding to the domestic circulation, overseas earnings exerted pressure on domestic interest rates.
For all of these reasons, the mercantilist preoccupation with the trade balance was not (as classical economics had insisted) "little better than nonsense." Unlike the mercantilist zero-sum game of trade balances, the option of an autonomous domestic interest rate was open to all, so that all countries can contribute to the quite remarkable result of "restoring economic health and
The use of money released mankind from close dependence on nature and local markets; but, in facilitating a high degree of specialization and exchange, money has caused individuals to rely on the entrepreneurial success of others. Yet, even those normal hazards of business and trading relationships can be exacerbated by an untrustworthy monetary system. Price signals - the means by which diverse activity is coordinated - are corrupted by monetary disturbances. The nature and detail of that disruption is the focus of monetary economics, where a primary requirement is to identify ideal conditions whereby economic coordination may best be achieved.
Related Results
The influence of money is described as "neutral," when it neither impedes nor enhances activity in real sectors of the economy. With neutrality, markets and money are analogous to engines and lubricating oil. The fundamentals of free exchange or engineering can be explained in the absence of money or lubricating oil, but the practicalities remain. Neutral money, like a frictionless engine, provides a conceptual benchmark. It is an abstraction, the conditions for which can "never be given in the real world." So, there is no corresponding stratagem: no "maxim which is immediately applicable to the practical problems of monetary policy" (Hayek, 1935, p. 129). The concept of neutral money is simply an enabling device to reach a greater depth of understanding of the essential problems of the money economy.
In practice, money cannot be neutral. Not least for the fact that it does not exist in a pure form,(1) the presence of money necessarily intrudes on the circumstances of real resources allocation and exchange. Whether in the context of classical economics or that of more recent macroeconomics, many of the economic "bads" that are associated with business cycles and international payments disequilibria originate in monetary disturbances. Yet, the explanations that are provided by classical theory are very different from those of Keynes' General Theory. So, it is necessary to exercise judgment on their respective plausibility.
Related Results
The influence of money is described as "neutral," when it neither impedes nor enhances activity in real sectors of the economy. With neutrality, markets and money are analogous to engines and lubricating oil. The fundamentals of free exchange or engineering can be explained in the absence of money or lubricating oil, but the practicalities remain. Neutral money, like a frictionless engine, provides a conceptual benchmark. It is an abstraction, the conditions for which can "never be given in the real world." So, there is no corresponding stratagem: no "maxim which is immediately applicable to the practical problems of monetary policy" (Hayek, 1935, p. 129). The concept of neutral money is simply an enabling device to reach a greater depth of understanding of the essential problems of the money economy.
In practice, money cannot be neutral. Not least for the fact that it does not exist in a pure form,(1) the presence of money necessarily intrudes on the circumstances of real resources allocation and exchange. Whether in the context of classical economics or that of more recent macroeconomics, many of the economic "bads" that are associated with business cycles and international payments disequilibria originate in monetary disturbances. Yet, the explanations that are provided by classical theory are very different from those of Keynes' General Theory. So, it is necessary to exercise judgment on their respective plausibility.
With the denunciation of mercantilism, the goal of economic activity was reformulated: wealth accumulation by the state was superseded by the satisfaction of individuals' wants. The latter would not be served by the accumulation of export surpluses. Furthermore, the impartial and spontaneous mechanisms (encompassed by Adam Smith's "invisible hand"), were the secure means by which independent economic action was coordinated. By the market mechanism of continuous price adjustments, demand and supply were moved toward harmony. Although unexpected developments were endemic, personal incentives motivated and informed speculative entrepreneurship. Through active and competitive bidding, entrepreneurs drove money prices toward a mutually consistent configuration. There was no claim to optimality. Rather, the system of market price adjustments offered a practical arrangement for the production and distribution of wealth across an extended economic order.
Related Results
Yet, in addressing the issue of the consequences (for market price signals) of monetary disturbances, the classical paradigm was developed far beyond Say's Law. The expectation that money would be neutral was plausibly argued to hold for the long run; but what of the more immediate consequences for economic activity, of changes in the volume of money in circulation?
IKeynes expressed his dissatisfaction with the central concept of the loanable funds theory; that is, the natural rate of interest. By the argument that for every shift in demand (for funds to finance investment expenditures) there are corresponding shifts in levels of national income and savings, Keynes introduced the paradox of thrift, the multiplier process, and the conclusion that the natural rate "had nothing very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo" (Keynes, 1936, p. 243). He suggested the existence of many different natural rates of interest, each one corresponding to a unique level of (un)employment equilibrium. Keynes' argument was that an expansion of investment (demand for loanable funds) raises production, so that incomes and savings (supply of loanable funds) also rise; and if shifts in demand cause shifts in supply, there is no determinate theory of price (interest rate). Demand and supply in the market for credit was irrelevant and the loanable funds theory defunct!
Related Results
According to Keynes, the interest rate is set by the choice of portfolio assets. A highly liquid asset (money) bears zero (or a relatively low) yield and is held only on the speculative expectation that the prices of bonds (and other financial securities) are more likely to fall (incurring a capital loss to holders) than to rise. The balance of speculation in financial markets determined the optimum quanta of holdings of money and less liquid securities. The thesis is that the rate of interest is determined by transactions between those (selling bonds) who feel that bond prices were more likely to fall and those (buying bonds) who feel that bond prices were more likely to rise.
The speculation that bond prices might rise (or fall) is identical with the speculation that the rate of interest might fall (or rise) and provides the substance behind Keynes' musing that, "[i]t is interesting that the stability of the system and its sensitiveness to changes in the quantity of money should be so dependent on the existence of a variety of opinion about what is uncertain. Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ" (Keynes, 1936, p. 172). Keynes believed that by adjusting the relative volumes of money and bonds in circulation, the authorities could manipulate the money price and yield of bonds. Interest rates could be set by action that would alter the weight of opinion as to whether bond prices were more likely to fall or rise. The objection that his analysis was deficient in that it did not say how the interest rate would be determined in the absence or uniformity of specific thoughts as to future bond prices was largely ignored.(6) There is always (in Keynes' terminology) a speculative demand to hold money from individuals who are speculating on a rise in the rate of interest. Moreover, Keynes' curious explanation for the inapplicability of this "liquidity preference theory of interest rate determination" to the United States - "where everyone tends to hold the same opinion at the same time" (Keynes, 1936, p. 172) - attracted little comment.
Keynes' crucial idea, that monetary expansion would dissipate its force in financial markets (on the price of bonds), rather than in markets generally - "[t]he primary effect of a change in the quantity of money . . . is through its influence on the rate of interest" (Keynes, 1936, p. 298) - necessitated the abandonment of a second plank of classical economics: the quantity theory of money. Here, Keynes argued that, "an increase in the quantity of money will have no effect whatever on prices, so long as there is any unemployment . . . whilst as soon as full employment is reached, it will be the wage unit and prices which will increase in exact proportion to the increase in effective demand" (Keynes, 1936, p. 295), and "[s]o long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money" (Keynes, 1936, p. 296). Keynes showed no concern that his new liquidity preference theory was exposed to the same criticism as that which he leveled against the loanable funds theory: at full employment, it has "nothing very useful or significant to contribute" because an expansion of money supply raises prices, which raises the transaction's demand for money; and if a shift in supply causes a shift in demand, the theory is indeterminate.
Related Results
The intellectual force of Dennis Robertson's early and persistent criticisms of Keynes' liquidity preference theory is substantial and acknowledged more readily than erstwhile (see, for example, Bridel, 1987, pp. 170-81; Fletcher, 1987). Indeed, Keynes' own claims were modest enough, "[t]he resulting theory, whether right or wrong, is exceedingly simple - namely that the rate of interest on a loan . . . equalises the attraction of holding idle cash and of holding the loan. It would be true to say that this does not carry us very far" (Keynes, cited from Bridel, 1987, p. 171) but he knew that his new principle of effective demand would be invalid in the presence of the long-established loanable funds theory. With the latter, there is no income multiplier, no principle of effective demand, no paradox of thrift and no macroeconomic explanation of unemployment.
Related Results
Yet, in addressing the issue of the consequences (for market price signals) of monetary disturbances, the classical paradigm was developed far beyond Say's Law. The expectation that money would be neutral was plausibly argued to hold for the long run; but what of the more immediate consequences for economic activity, of changes in the volume of money in circulation?
IKeynes expressed his dissatisfaction with the central concept of the loanable funds theory; that is, the natural rate of interest. By the argument that for every shift in demand (for funds to finance investment expenditures) there are corresponding shifts in levels of national income and savings, Keynes introduced the paradox of thrift, the multiplier process, and the conclusion that the natural rate "had nothing very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo" (Keynes, 1936, p. 243). He suggested the existence of many different natural rates of interest, each one corresponding to a unique level of (un)employment equilibrium. Keynes' argument was that an expansion of investment (demand for loanable funds) raises production, so that incomes and savings (supply of loanable funds) also rise; and if shifts in demand cause shifts in supply, there is no determinate theory of price (interest rate). Demand and supply in the market for credit was irrelevant and the loanable funds theory defunct!
Related Results
According to Keynes, the interest rate is set by the choice of portfolio assets. A highly liquid asset (money) bears zero (or a relatively low) yield and is held only on the speculative expectation that the prices of bonds (and other financial securities) are more likely to fall (incurring a capital loss to holders) than to rise. The balance of speculation in financial markets determined the optimum quanta of holdings of money and less liquid securities. The thesis is that the rate of interest is determined by transactions between those (selling bonds) who feel that bond prices were more likely to fall and those (buying bonds) who feel that bond prices were more likely to rise.
The speculation that bond prices might rise (or fall) is identical with the speculation that the rate of interest might fall (or rise) and provides the substance behind Keynes' musing that, "[i]t is interesting that the stability of the system and its sensitiveness to changes in the quantity of money should be so dependent on the existence of a variety of opinion about what is uncertain. Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ" (Keynes, 1936, p. 172). Keynes believed that by adjusting the relative volumes of money and bonds in circulation, the authorities could manipulate the money price and yield of bonds. Interest rates could be set by action that would alter the weight of opinion as to whether bond prices were more likely to fall or rise. The objection that his analysis was deficient in that it did not say how the interest rate would be determined in the absence or uniformity of specific thoughts as to future bond prices was largely ignored.(6) There is always (in Keynes' terminology) a speculative demand to hold money from individuals who are speculating on a rise in the rate of interest. Moreover, Keynes' curious explanation for the inapplicability of this "liquidity preference theory of interest rate determination" to the United States - "where everyone tends to hold the same opinion at the same time" (Keynes, 1936, p. 172) - attracted little comment.
Keynes' crucial idea, that monetary expansion would dissipate its force in financial markets (on the price of bonds), rather than in markets generally - "[t]he primary effect of a change in the quantity of money . . . is through its influence on the rate of interest" (Keynes, 1936, p. 298) - necessitated the abandonment of a second plank of classical economics: the quantity theory of money. Here, Keynes argued that, "an increase in the quantity of money will have no effect whatever on prices, so long as there is any unemployment . . . whilst as soon as full employment is reached, it will be the wage unit and prices which will increase in exact proportion to the increase in effective demand" (Keynes, 1936, p. 295), and "[s]o long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money" (Keynes, 1936, p. 296). Keynes showed no concern that his new liquidity preference theory was exposed to the same criticism as that which he leveled against the loanable funds theory: at full employment, it has "nothing very useful or significant to contribute" because an expansion of money supply raises prices, which raises the transaction's demand for money; and if a shift in supply causes a shift in demand, the theory is indeterminate.
Related Results
The intellectual force of Dennis Robertson's early and persistent criticisms of Keynes' liquidity preference theory is substantial and acknowledged more readily than erstwhile (see, for example, Bridel, 1987, pp. 170-81; Fletcher, 1987). Indeed, Keynes' own claims were modest enough, "[t]he resulting theory, whether right or wrong, is exceedingly simple - namely that the rate of interest on a loan . . . equalises the attraction of holding idle cash and of holding the loan. It would be true to say that this does not carry us very far" (Keynes, cited from Bridel, 1987, p. 171) but he knew that his new principle of effective demand would be invalid in the presence of the long-established loanable funds theory. With the latter, there is no income multiplier, no principle of effective demand, no paradox of thrift and no macroeconomic explanation of unemployment.
Keynes' View of Mercantilism
Keynes' criticisms of Say's Law were focused on the proposition (which Keynes took to be Say's Law) that competition tends always to cause output to expand to the point of full resource utilization: [t]hus, Say's law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment" (Keynes, 1936, p. 26). Indeed, the whole purpose of Keynes' General Theory was to propagate the idea that market forces do not necessarily sustain a full employment level of output; and, once Keynes had targeted Say's Law, it is consistent that he should have discovered merit in mercantilism.
Related Results
That there is an "element of scientific truth" in the mercantilist doctrine followed from the proposition of The General Theory that the interest rate and the level of investment did not self-adjust to levels compatible with full employment. So arose the necessity to eliminate the interest rate as the mechanism that channeled saving via the market for loanable funds, to meet a demand for investment goods. With the liquidity preference interest rate theory, an excessive speculative demand to hold money (or "high liquidity preference") set a high interest rate, and a low level of investment expenditure. It was then possible to regard aggregate demand as deficient, in the sense that it would be opportune if some means could be established to increase investment expenditure.
In an international context, variations in the money supply (and, according to Keynes' analysis, variations in the interest rate) were largely dependent on the balance of payments, from which derived the "avowedly national advantages" of the mercantilist doctrine. A trade surplus boosts the domestic circulation of money. Yet, because mercantilism was unashamedly a beggar-my-neighbor approach, it also gave a tendency to drift into war, which was a serious flaw! Keynes argued that the mercantilists had recognized the nature of these problems but had been unable "to push their analysis to the point of solving it." The solution that had been missed was that of applying "the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment program directed to an optimal level of domestic development (Keynes, 1936, p. 349).
An economy with chronic unemployment faces two problems: it is short of remunerative investment opportunities at home and it requires the means to bring down the domestic rate of interest. The mercantilist objective - a trade surplus - gave a remedy in three parts: overseas markets brought enhanced returns on investment; foreign currency earnings offered the means to finance overseas investment; and, by adding to the domestic circulation, overseas earnings exerted pressure on domestic interest rates.
For all of these reasons, the mercantilist preoccupation with the trade balance was not (as classical economics had insisted) "little better than nonsense." Unlike the mercantilist zero-sum game of trade balances, the option of an autonomous domestic interest rate was open to all, so that all countries can contribute to the quite remarkable result of "restoring economic health and
Keynes' criticisms of Say's Law were focused on the proposition (which Keynes took to be Say's Law) that competition tends always to cause output to expand to the point of full resource utilization: [t]hus, Say's law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment" (Keynes, 1936, p. 26). Indeed, the whole purpose of Keynes' General Theory was to propagate the idea that market forces do not necessarily sustain a full employment level of output; and, once Keynes had targeted Say's Law, it is consistent that he should have discovered merit in mercantilism.
Related Results
That there is an "element of scientific truth" in the mercantilist doctrine followed from the proposition of The General Theory that the interest rate and the level of investment did not self-adjust to levels compatible with full employment. So arose the necessity to eliminate the interest rate as the mechanism that channeled saving via the market for loanable funds, to meet a demand for investment goods. With the liquidity preference interest rate theory, an excessive speculative demand to hold money (or "high liquidity preference") set a high interest rate, and a low level of investment expenditure. It was then possible to regard aggregate demand as deficient, in the sense that it would be opportune if some means could be established to increase investment expenditure.
In an international context, variations in the money supply (and, according to Keynes' analysis, variations in the interest rate) were largely dependent on the balance of payments, from which derived the "avowedly national advantages" of the mercantilist doctrine. A trade surplus boosts the domestic circulation of money. Yet, because mercantilism was unashamedly a beggar-my-neighbor approach, it also gave a tendency to drift into war, which was a serious flaw! Keynes argued that the mercantilists had recognized the nature of these problems but had been unable "to push their analysis to the point of solving it." The solution that had been missed was that of applying "the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment program directed to an optimal level of domestic development (Keynes, 1936, p. 349).
An economy with chronic unemployment faces two problems: it is short of remunerative investment opportunities at home and it requires the means to bring down the domestic rate of interest. The mercantilist objective - a trade surplus - gave a remedy in three parts: overseas markets brought enhanced returns on investment; foreign currency earnings offered the means to finance overseas investment; and, by adding to the domestic circulation, overseas earnings exerted pressure on domestic interest rates.
For all of these reasons, the mercantilist preoccupation with the trade balance was not (as classical economics had insisted) "little better than nonsense." Unlike the mercantilist zero-sum game of trade balances, the option of an autonomous domestic interest rate was open to all, so that all countries can contribute to the quite remarkable result of "restoring economic health and
the dollar will always be important
The influence of dollar on various assets is very high. How it influences us this time around, however remains to be seen.
Understanding the dollar is as important as understanding commodities, equities and bond cycles. The currency is a global benchmark and it is this dollar link that completes the economic cycle as assets interact with each other.
Unfortunately, we do not pay much attention to this link. The geographical bias, lack of inter-market knowledge, single asset focus and cycle blindness restrains our understanding of the currency.
The dollar is as important as gold. The two assets mirror each other and run contrary. If gold strengthens, dollar weakens and vice-versa. It is the classic interaction between the tangible and the intangible -- gold and commodities being the hard or tangible assets and the dollar being the intangible or paper asset.
Cash is an important aspect of society and, even if we are moving ahead to a more inflationary time, understanding cash cycles was never more important. Rather, there have been times when gold was given less importance than the dollar.
In 1928, D H Robertson said, 'The value of the yellow metal, originally chosen as money because it tickled the fancy of savages, is clearly a chancy and irrelevant thing on which to base the value of our money and the stability of our industrial system.' The quote, more relevant then, might seem so out of place today. But the choice between gold and dollar is as cyclical as ever.
The American experience shows how debates about the nature of money, the control of the amount of money in circulation and how the relationship between gold, silver and paper had moved to the centre of political stage in the nineteenth century. This was a new phenomenon in the history of money, caused by the extensive development of paper money and the constantly changing economic and political conditions of the modern world.
In the book Money, A History, Catherine Eagleton and Jonathon Williams explain how on one side economic disasters were linked to the uncontrolled issue of paper money and, on the other side, it was a metal that faced vagaries of increased supply or a chance discovery.
Though we have managed some of the old problems of the economic society, we are still moving in and out of an implicit gold standard. And, in some ways, the dollar is more important than gold today. Important, in terms the exposure we have to the dollar as compared to gold. The industrialisation of the global economy and consumerism of commodities are at a historical high. So, we have moved from the classical dollar and gold equation to dollar and consumption as a whole.
Dollar is the global cash proxy today. Even if we deny it, a dollar strengthening or weakening for a few months can impose a reversal in trends of global assets. Econohistory is replete with incidents of cycles in the debasement of currency and currency crisis. There are cycles from 18 years, 54 years, 108 years and 300 years. These patterns have been dominant back through time to the era before Christ.
Understanding the dollar is as important as understanding commodities, equities and bond cycles. The currency is a global benchmark and it is this dollar link that completes the economic cycle as assets interact with each other.
Unfortunately, we do not pay much attention to this link. The geographical bias, lack of inter-market knowledge, single asset focus and cycle blindness restrains our understanding of the currency.
The dollar is as important as gold. The two assets mirror each other and run contrary. If gold strengthens, dollar weakens and vice-versa. It is the classic interaction between the tangible and the intangible -- gold and commodities being the hard or tangible assets and the dollar being the intangible or paper asset.
Cash is an important aspect of society and, even if we are moving ahead to a more inflationary time, understanding cash cycles was never more important. Rather, there have been times when gold was given less importance than the dollar.
In 1928, D H Robertson said, 'The value of the yellow metal, originally chosen as money because it tickled the fancy of savages, is clearly a chancy and irrelevant thing on which to base the value of our money and the stability of our industrial system.' The quote, more relevant then, might seem so out of place today. But the choice between gold and dollar is as cyclical as ever.
The American experience shows how debates about the nature of money, the control of the amount of money in circulation and how the relationship between gold, silver and paper had moved to the centre of political stage in the nineteenth century. This was a new phenomenon in the history of money, caused by the extensive development of paper money and the constantly changing economic and political conditions of the modern world.
In the book Money, A History, Catherine Eagleton and Jonathon Williams explain how on one side economic disasters were linked to the uncontrolled issue of paper money and, on the other side, it was a metal that faced vagaries of increased supply or a chance discovery.
Though we have managed some of the old problems of the economic society, we are still moving in and out of an implicit gold standard. And, in some ways, the dollar is more important than gold today. Important, in terms the exposure we have to the dollar as compared to gold. The industrialisation of the global economy and consumerism of commodities are at a historical high. So, we have moved from the classical dollar and gold equation to dollar and consumption as a whole.
Dollar is the global cash proxy today. Even if we deny it, a dollar strengthening or weakening for a few months can impose a reversal in trends of global assets. Econohistory is replete with incidents of cycles in the debasement of currency and currency crisis. There are cycles from 18 years, 54 years, 108 years and 300 years. These patterns have been dominant back through time to the era before Christ.
The use of money released mankind from close dependence on nature and local markets; but, in facilitating a high degree of specialization and exchange, money has caused individuals to rely on the entrepreneurial success of others. Yet, even those normal hazards of business and trading relationships can be exacerbated by an untrustworthy monetary system. Price signals - the means by which diverse activity is coordinated - are corrupted by monetary disturbances. The nature and detail of that disruption is the focus of monetary economics, where a primary requirement is to identify ideal conditions whereby economic coordination may best be achieved.
Related Results
The influence of money is described as "neutral," when it neither impedes nor enhances activity in real sectors of the economy. With neutrality, markets and money are analogous to engines and lubricating oil. The fundamentals of free exchange or engineering can be explained in the absence of money or lubricating oil, but the practicalities remain. Neutral money, like a frictionless engine, provides a conceptual benchmark. It is an abstraction, the conditions for which can "never be given in the real world." So, there is no corresponding stratagem: no "maxim which is immediately applicable to the practical problems of monetary policy" (Hayek, 1935, p. 129). The concept of neutral money is simply an enabling device to reach a greater depth of understanding of the essential problems of the money economy.
In practice, money cannot be neutral. Not least for the fact that it does not exist in a pure form,(1) the presence of money necessarily intrudes on the circumstances of real resources allocation and exchange. Whether in the context of classical economics or that of more recent macroeconomics, many of the economic "bads" that are associated with business cycles and international payments disequilibria originate in monetary disturbances. Yet, the explanations that are provided by classical theory are very different from those of Keynes' General Theory. So, it is necessary to exercise judgment on their respective plausibility.
Related Results
The influence of money is described as "neutral," when it neither impedes nor enhances activity in real sectors of the economy. With neutrality, markets and money are analogous to engines and lubricating oil. The fundamentals of free exchange or engineering can be explained in the absence of money or lubricating oil, but the practicalities remain. Neutral money, like a frictionless engine, provides a conceptual benchmark. It is an abstraction, the conditions for which can "never be given in the real world." So, there is no corresponding stratagem: no "maxim which is immediately applicable to the practical problems of monetary policy" (Hayek, 1935, p. 129). The concept of neutral money is simply an enabling device to reach a greater depth of understanding of the essential problems of the money economy.
In practice, money cannot be neutral. Not least for the fact that it does not exist in a pure form,(1) the presence of money necessarily intrudes on the circumstances of real resources allocation and exchange. Whether in the context of classical economics or that of more recent macroeconomics, many of the economic "bads" that are associated with business cycles and international payments disequilibria originate in monetary disturbances. Yet, the explanations that are provided by classical theory are very different from those of Keynes' General Theory. So, it is necessary to exercise judgment on their respective plausibility.
With the denunciation of mercantilism, the goal of economic activity was reformulated: wealth accumulation by the state was superseded by the satisfaction of individuals' wants. The latter would not be served by the accumulation of export surpluses. Furthermore, the impartial and spontaneous mechanisms (encompassed by Adam Smith's "invisible hand"), were the secure means by which independent economic action was coordinated. By the market mechanism of continuous price adjustments, demand and supply were moved toward harmony. Although unexpected developments were endemic, personal incentives motivated and informed speculative entrepreneurship. Through active and competitive bidding, entrepreneurs drove money prices toward a mutually consistent configuration. There was no claim to optimality. Rather, the system of market price adjustments offered a practical arrangement for the production and distribution of wealth across an extended economic order.
Related Results
Yet, in addressing the issue of the consequences (for market price signals) of monetary disturbances, the classical paradigm was developed far beyond Say's Law. The expectation that money would be neutral was plausibly argued to hold for the long run; but what of the more immediate consequences for economic activity, of changes in the volume of money in circulation?
IKeynes expressed his dissatisfaction with the central concept of the loanable funds theory; that is, the natural rate of interest. By the argument that for every shift in demand (for funds to finance investment expenditures) there are corresponding shifts in levels of national income and savings, Keynes introduced the paradox of thrift, the multiplier process, and the conclusion that the natural rate "had nothing very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo" (Keynes, 1936, p. 243). He suggested the existence of many different natural rates of interest, each one corresponding to a unique level of (un)employment equilibrium. Keynes' argument was that an expansion of investment (demand for loanable funds) raises production, so that incomes and savings (supply of loanable funds) also rise; and if shifts in demand cause shifts in supply, there is no determinate theory of price (interest rate). Demand and supply in the market for credit was irrelevant and the loanable funds theory defunct!
Related Results
According to Keynes, the interest rate is set by the choice of portfolio assets. A highly liquid asset (money) bears zero (or a relatively low) yield and is held only on the speculative expectation that the prices of bonds (and other financial securities) are more likely to fall (incurring a capital loss to holders) than to rise. The balance of speculation in financial markets determined the optimum quanta of holdings of money and less liquid securities. The thesis is that the rate of interest is determined by transactions between those (selling bonds) who feel that bond prices were more likely to fall and those (buying bonds) who feel that bond prices were more likely to rise.
The speculation that bond prices might rise (or fall) is identical with the speculation that the rate of interest might fall (or rise) and provides the substance behind Keynes' musing that, "[i]t is interesting that the stability of the system and its sensitiveness to changes in the quantity of money should be so dependent on the existence of a variety of opinion about what is uncertain. Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ" (Keynes, 1936, p. 172). Keynes believed that by adjusting the relative volumes of money and bonds in circulation, the authorities could manipulate the money price and yield of bonds. Interest rates could be set by action that would alter the weight of opinion as to whether bond prices were more likely to fall or rise. The objection that his analysis was deficient in that it did not say how the interest rate would be determined in the absence or uniformity of specific thoughts as to future bond prices was largely ignored.(6) There is always (in Keynes' terminology) a speculative demand to hold money from individuals who are speculating on a rise in the rate of interest. Moreover, Keynes' curious explanation for the inapplicability of this "liquidity preference theory of interest rate determination" to the United States - "where everyone tends to hold the same opinion at the same time" (Keynes, 1936, p. 172) - attracted little comment.
Keynes' crucial idea, that monetary expansion would dissipate its force in financial markets (on the price of bonds), rather than in markets generally - "[t]he primary effect of a change in the quantity of money . . . is through its influence on the rate of interest" (Keynes, 1936, p. 298) - necessitated the abandonment of a second plank of classical economics: the quantity theory of money. Here, Keynes argued that, "an increase in the quantity of money will have no effect whatever on prices, so long as there is any unemployment . . . whilst as soon as full employment is reached, it will be the wage unit and prices which will increase in exact proportion to the increase in effective demand" (Keynes, 1936, p. 295), and "[s]o long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money" (Keynes, 1936, p. 296). Keynes showed no concern that his new liquidity preference theory was exposed to the same criticism as that which he leveled against the loanable funds theory: at full employment, it has "nothing very useful or significant to contribute" because an expansion of money supply raises prices, which raises the transaction's demand for money; and if a shift in supply causes a shift in demand, the theory is indeterminate.
Related Results
The intellectual force of Dennis Robertson's early and persistent criticisms of Keynes' liquidity preference theory is substantial and acknowledged more readily than erstwhile (see, for example, Bridel, 1987, pp. 170-81; Fletcher, 1987). Indeed, Keynes' own claims were modest enough, "[t]he resulting theory, whether right or wrong, is exceedingly simple - namely that the rate of interest on a loan . . . equalises the attraction of holding idle cash and of holding the loan. It would be true to say that this does not carry us very far" (Keynes, cited from Bridel, 1987, p. 171) but he knew that his new principle of effective demand would be invalid in the presence of the long-established loanable funds theory. With the latter, there is no income multiplier, no principle of effective demand, no paradox of thrift and no macroeconomic explanation of unemployment.
Related Results
Yet, in addressing the issue of the consequences (for market price signals) of monetary disturbances, the classical paradigm was developed far beyond Say's Law. The expectation that money would be neutral was plausibly argued to hold for the long run; but what of the more immediate consequences for economic activity, of changes in the volume of money in circulation?
IKeynes expressed his dissatisfaction with the central concept of the loanable funds theory; that is, the natural rate of interest. By the argument that for every shift in demand (for funds to finance investment expenditures) there are corresponding shifts in levels of national income and savings, Keynes introduced the paradox of thrift, the multiplier process, and the conclusion that the natural rate "had nothing very useful or significant to contribute to our analysis. It is merely the rate of interest which will preserve the status quo" (Keynes, 1936, p. 243). He suggested the existence of many different natural rates of interest, each one corresponding to a unique level of (un)employment equilibrium. Keynes' argument was that an expansion of investment (demand for loanable funds) raises production, so that incomes and savings (supply of loanable funds) also rise; and if shifts in demand cause shifts in supply, there is no determinate theory of price (interest rate). Demand and supply in the market for credit was irrelevant and the loanable funds theory defunct!
Related Results
According to Keynes, the interest rate is set by the choice of portfolio assets. A highly liquid asset (money) bears zero (or a relatively low) yield and is held only on the speculative expectation that the prices of bonds (and other financial securities) are more likely to fall (incurring a capital loss to holders) than to rise. The balance of speculation in financial markets determined the optimum quanta of holdings of money and less liquid securities. The thesis is that the rate of interest is determined by transactions between those (selling bonds) who feel that bond prices were more likely to fall and those (buying bonds) who feel that bond prices were more likely to rise.
The speculation that bond prices might rise (or fall) is identical with the speculation that the rate of interest might fall (or rise) and provides the substance behind Keynes' musing that, "[i]t is interesting that the stability of the system and its sensitiveness to changes in the quantity of money should be so dependent on the existence of a variety of opinion about what is uncertain. Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ" (Keynes, 1936, p. 172). Keynes believed that by adjusting the relative volumes of money and bonds in circulation, the authorities could manipulate the money price and yield of bonds. Interest rates could be set by action that would alter the weight of opinion as to whether bond prices were more likely to fall or rise. The objection that his analysis was deficient in that it did not say how the interest rate would be determined in the absence or uniformity of specific thoughts as to future bond prices was largely ignored.(6) There is always (in Keynes' terminology) a speculative demand to hold money from individuals who are speculating on a rise in the rate of interest. Moreover, Keynes' curious explanation for the inapplicability of this "liquidity preference theory of interest rate determination" to the United States - "where everyone tends to hold the same opinion at the same time" (Keynes, 1936, p. 172) - attracted little comment.
Keynes' crucial idea, that monetary expansion would dissipate its force in financial markets (on the price of bonds), rather than in markets generally - "[t]he primary effect of a change in the quantity of money . . . is through its influence on the rate of interest" (Keynes, 1936, p. 298) - necessitated the abandonment of a second plank of classical economics: the quantity theory of money. Here, Keynes argued that, "an increase in the quantity of money will have no effect whatever on prices, so long as there is any unemployment . . . whilst as soon as full employment is reached, it will be the wage unit and prices which will increase in exact proportion to the increase in effective demand" (Keynes, 1936, p. 295), and "[s]o long as there is unemployment, employment will change in the same proportion as the quantity of money; and when there is full employment, prices will change in the same proportion as the quantity of money" (Keynes, 1936, p. 296). Keynes showed no concern that his new liquidity preference theory was exposed to the same criticism as that which he leveled against the loanable funds theory: at full employment, it has "nothing very useful or significant to contribute" because an expansion of money supply raises prices, which raises the transaction's demand for money; and if a shift in supply causes a shift in demand, the theory is indeterminate.
Related Results
The intellectual force of Dennis Robertson's early and persistent criticisms of Keynes' liquidity preference theory is substantial and acknowledged more readily than erstwhile (see, for example, Bridel, 1987, pp. 170-81; Fletcher, 1987). Indeed, Keynes' own claims were modest enough, "[t]he resulting theory, whether right or wrong, is exceedingly simple - namely that the rate of interest on a loan . . . equalises the attraction of holding idle cash and of holding the loan. It would be true to say that this does not carry us very far" (Keynes, cited from Bridel, 1987, p. 171) but he knew that his new principle of effective demand would be invalid in the presence of the long-established loanable funds theory. With the latter, there is no income multiplier, no principle of effective demand, no paradox of thrift and no macroeconomic explanation of unemployment.
Keynes' View of Mercantilism
Keynes' criticisms of Say's Law were focused on the proposition (which Keynes took to be Say's Law) that competition tends always to cause output to expand to the point of full resource utilization: [t]hus, Say's law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment" (Keynes, 1936, p. 26). Indeed, the whole purpose of Keynes' General Theory was to propagate the idea that market forces do not necessarily sustain a full employment level of output; and, once Keynes had targeted Say's Law, it is consistent that he should have discovered merit in mercantilism.
Related Results
That there is an "element of scientific truth" in the mercantilist doctrine followed from the proposition of The General Theory that the interest rate and the level of investment did not self-adjust to levels compatible with full employment. So arose the necessity to eliminate the interest rate as the mechanism that channeled saving via the market for loanable funds, to meet a demand for investment goods. With the liquidity preference interest rate theory, an excessive speculative demand to hold money (or "high liquidity preference") set a high interest rate, and a low level of investment expenditure. It was then possible to regard aggregate demand as deficient, in the sense that it would be opportune if some means could be established to increase investment expenditure.
In an international context, variations in the money supply (and, according to Keynes' analysis, variations in the interest rate) were largely dependent on the balance of payments, from which derived the "avowedly national advantages" of the mercantilist doctrine. A trade surplus boosts the domestic circulation of money. Yet, because mercantilism was unashamedly a beggar-my-neighbor approach, it also gave a tendency to drift into war, which was a serious flaw! Keynes argued that the mercantilists had recognized the nature of these problems but had been unable "to push their analysis to the point of solving it." The solution that had been missed was that of applying "the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment program directed to an optimal level of domestic development (Keynes, 1936, p. 349).
An economy with chronic unemployment faces two problems: it is short of remunerative investment opportunities at home and it requires the means to bring down the domestic rate of interest. The mercantilist objective - a trade surplus - gave a remedy in three parts: overseas markets brought enhanced returns on investment; foreign currency earnings offered the means to finance overseas investment; and, by adding to the domestic circulation, overseas earnings exerted pressure on domestic interest rates.
For all of these reasons, the mercantilist preoccupation with the trade balance was not (as classical economics had insisted) "little better than nonsense." Unlike the mercantilist zero-sum game of trade balances, the option of an autonomous domestic interest rate was open to all, so that all countries can contribute to the quite remarkable result of "restoring economic health and
Dollar weakness started at the base of the commodity cycle in 2000. While commodities soared, the dollar lost its value. In October 2007 (The rupee correlation), we said, "The big surprise always happens when people least expect it. We do not see the rupee appreciating beyond Rs 38, it is a turning point for us. And we are not far from a dollar surprise as it turns around for a multi-month of strengthening." This is what happened to the dollar. Starting March 2008, the dollar stopped weakening and is nearing back to January 2008 levels. The Indian currency turned from a low at Rs 39 in November 2007 and is back to Rs 44, at 2006 levels.
Though immediate targets for dollar lie near 1.45 levels (EURO-USD), we are anticipating a multi-month of strengthening back to January 2005 levels of sub-1.4. This means that our case of commodity weakness and multi-month of global equity reprieve starting October 2008 remains valid.
There are more reasons why we think that the dollar strengthening is here for more than a few weeks. There have been prior occasions of marginal dollar strengthening. But there are only a few times that other currency pairs and assets also come in focus. The current bout of dollar strengthening also affected the British pound, which fell to a two-year low. And both oil and gold also witnessed sharp drawdowns. This is a classic confluence and comes at a time when the world is waiting for a recession, a financial crisis, oil at $ 200 and higher gold prices.
Even sentiment against the dollar is at extreme levels. The negativity has also entered mass psychology and magazine covers still question whether the dollar comeback is for real.
Investment strategists also mention about the commodity and oil markets used as hedge against a falling dollar. These linkages also break if dollar strengthens and oil drops. It is only after the trend strengthens that generally trend news starts appearing, like now, with American GDP numbers beating analyst expectations at 3.3 per cent. In the process of crying negativity about the dollar, the masses forgot that falling currency value also leads to flourishing exports.
We are in unprecedented times, which is no way similar to the discovery of gold near Sacramento in 1848 when within four years more than 1 per cent of the population of the United States had moved to California. Monetary economics has moved from the central banker, to the state, to the markets ruled by the mob. This time it is the global gold rush. How dollar influences us this time around, however remains to be seen.
The author is CEO, Orpheus CAPITALS, a global alternative research company.
Keynes' criticisms of Say's Law were focused on the proposition (which Keynes took to be Say's Law) that competition tends always to cause output to expand to the point of full resource utilization: [t]hus, Say's law, that the aggregate demand price of output as a whole is equal to its aggregate supply price for all volumes of output, is equivalent to the proposition that there is no obstacle to full employment" (Keynes, 1936, p. 26). Indeed, the whole purpose of Keynes' General Theory was to propagate the idea that market forces do not necessarily sustain a full employment level of output; and, once Keynes had targeted Say's Law, it is consistent that he should have discovered merit in mercantilism.
Related Results
That there is an "element of scientific truth" in the mercantilist doctrine followed from the proposition of The General Theory that the interest rate and the level of investment did not self-adjust to levels compatible with full employment. So arose the necessity to eliminate the interest rate as the mechanism that channeled saving via the market for loanable funds, to meet a demand for investment goods. With the liquidity preference interest rate theory, an excessive speculative demand to hold money (or "high liquidity preference") set a high interest rate, and a low level of investment expenditure. It was then possible to regard aggregate demand as deficient, in the sense that it would be opportune if some means could be established to increase investment expenditure.
In an international context, variations in the money supply (and, according to Keynes' analysis, variations in the interest rate) were largely dependent on the balance of payments, from which derived the "avowedly national advantages" of the mercantilist doctrine. A trade surplus boosts the domestic circulation of money. Yet, because mercantilism was unashamedly a beggar-my-neighbor approach, it also gave a tendency to drift into war, which was a serious flaw! Keynes argued that the mercantilists had recognized the nature of these problems but had been unable "to push their analysis to the point of solving it." The solution that had been missed was that of applying "the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment program directed to an optimal level of domestic development (Keynes, 1936, p. 349).
An economy with chronic unemployment faces two problems: it is short of remunerative investment opportunities at home and it requires the means to bring down the domestic rate of interest. The mercantilist objective - a trade surplus - gave a remedy in three parts: overseas markets brought enhanced returns on investment; foreign currency earnings offered the means to finance overseas investment; and, by adding to the domestic circulation, overseas earnings exerted pressure on domestic interest rates.
For all of these reasons, the mercantilist preoccupation with the trade balance was not (as classical economics had insisted) "little better than nonsense." Unlike the mercantilist zero-sum game of trade balances, the option of an autonomous domestic interest rate was open to all, so that all countries can contribute to the quite remarkable result of "restoring economic health and
Dollar weakness started at the base of the commodity cycle in 2000. While commodities soared, the dollar lost its value. In October 2007 (The rupee correlation), we said, "The big surprise always happens when people least expect it. We do not see the rupee appreciating beyond Rs 38, it is a turning point for us. And we are not far from a dollar surprise as it turns around for a multi-month of strengthening." This is what happened to the dollar. Starting March 2008, the dollar stopped weakening and is nearing back to January 2008 levels. The Indian currency turned from a low at Rs 39 in November 2007 and is back to Rs 44, at 2006 levels.
Though immediate targets for dollar lie near 1.45 levels (EURO-USD), we are anticipating a multi-month of strengthening back to January 2005 levels of sub-1.4. This means that our case of commodity weakness and multi-month of global equity reprieve starting October 2008 remains valid.
There are more reasons why we think that the dollar strengthening is here for more than a few weeks. There have been prior occasions of marginal dollar strengthening. But there are only a few times that other currency pairs and assets also come in focus. The current bout of dollar strengthening also affected the British pound, which fell to a two-year low. And both oil and gold also witnessed sharp drawdowns. This is a classic confluence and comes at a time when the world is waiting for a recession, a financial crisis, oil at $ 200 and higher gold prices.
Even sentiment against the dollar is at extreme levels. The negativity has also entered mass psychology and magazine covers still question whether the dollar comeback is for real.
Investment strategists also mention about the commodity and oil markets used as hedge against a falling dollar. These linkages also break if dollar strengthens and oil drops. It is only after the trend strengthens that generally trend news starts appearing, like now, with American GDP numbers beating analyst expectations at 3.3 per cent. In the process of crying negativity about the dollar, the masses forgot that falling currency value also leads to flourishing exports.
We are in unprecedented times, which is no way similar to the discovery of gold near Sacramento in 1848 when within four years more than 1 per cent of the population of the United States had moved to California. Monetary economics has moved from the central banker, to the state, to the markets ruled by the mob. This time it is the global gold rush. How dollar influences us this time around, however remains to be seen.
The author is CEO, Orpheus CAPITALS, a global alternative research company.
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