The Strange World of Major Freedom's Bizzaro Economics

     Lord Keynes-a site I've come to read quite often recently, I recommend you try it if you haven't as you learn a lot reading him-posted a link to Bob Murphy last year that seemed to suggest some non orthodox views among Austrians.

     http://socialdemocracy21stcentury.blogspot.com/2012/08/paul-krugman-versus-robert-murphy-debate.html

    Lord was commenting on this debate that Murphy is trying to goad Krugman into. Tom Woods recently made a little video addressed to Krugman which basically says, 'What's the matter are you chicken?"

    For Lord Keynes' part he says that he doesn't see why this debate is being pushed so much by the Austrians:

(1) Frankly, I wonder why Austrians are so hung up on Krugman. Maybe it is Nobel Memorial Prize in Economic Sciences he has, or his media prominence. As a mainstream neoclassical, Krugman represents a heavily neoclassical version of Keynesianism, and he most certainly does not represent all Keynesians.

(2) Woods tells us that Murphy is a member of the “free market Austrian school of economics.”

     "Yet it strikes me that Murphy is a highly idiosyncratic Austrian. His PhD Unanticipated Intertemporal Change in Theories of Interest (New York University, 2003) included (1) a critique of the pure time preference theory of interest (the view of the interest rate held by all Austrians I know), and (2) a defense of a monetary theory of interest. On his blog, he has cited a comment of Keynes on the monetary theory of interest with approval, which provoked a howl of protests from his regular readers:

Robert P. Murphy, “Is Keynes from Heaven or Hell,” 7 July 2011.
http://consultingbyrpm.com/blog/2011/07/is-keynes-from-heaven-or-hell.html

     In looking at last year's post I was amused to see that our old friend Major Freedom-I like to call him Major Unfreedom when he and I spar over at Money Illusion- had a feverish outburst because Murphy suggested that Keynes was right about something. Here's what Murphy said:

     "Sorry kids–Major Freedom in particular–but I think Keynes is brilliant in Chapter 13 of the General Theory:

It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before. On the contrary, the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period. For the rate of interest is, in itself, nothing more than the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt for a stated period of time.

     "As I put it in my neglected dissertation, the rate of interest is an exchange rate between present and future dollars (or euros or ounces of gold or whatever the money commodity is). Austrians wouldn’t explain the exchange rate between the USD and the Japanese yen by reference to “proximity preference,” or the fact that consumers subjective prefer, other things equal, American goods to Japanese goods."

     "Obviously, I don’t endorse Keynes’ nutjob “socialization of investment” stuff in the final chapter, or any of his policy recommendations for that matter. But on his neutral, scientific assessment of what interest is, I actually agree with him more than Mises."

     "Believe me, it pains me to say that. I feel like this guy.

     Listen to Major's answer though. Is this not the strangest economic lesson you have ever heard?

      "Yes, the nominal rate of interest on loans is the difference between money received in the future versus money given up in the present. But this difference cannot possibly be a product of liquidity preference, for this difference is not between what is hoarded and what is consumed and invested. It is the difference between what is consumed and invested only."

     "Imagine everyone in the economy hoarding maximum cash, and investing the minimum and consuming the maximum out of the remainder, versus an economy where everyone is hoarding minimum cash, and investing the minimum and consuming the maximum out of the remainder."

     "To give some numbers to this, imagine in the first economy everyone comes to hoard $900 each, and they earn $100 per period, which they invest $10 and consume $90. In the second economy, everyone comes to hoard only $100, and they earn $900 each period, which they invest $100 and consume $900."

      "What will the interest rates, or rather the interest rate (since everyone has the exact same spending/hoarding/investing patterns) tend to be in each economy? According to Keynes, because the liquidity preference is so much more higher in the first economy than in the second economy, the interest rate should be drastically different in the first economy relative to the second economy. But will they be different?"

      "No. Here’s why:

       "In the first economy, aggregate investment is $10*N and aggregate consumption is $90*N (N = number of individuals). This means that out of all money received through sales (labor, goods, etc), which is ($10 + $90)*N = $100*N, there will be $10 that will show up as business costs (ignore depreciation and assume for simplicity that the $10*N capital invested each year is used up each year) and $100*N that will show up as revenues."

      "Here, the “natural” profit in the first economy will be the difference between aggregate revenues and aggregate costs. Aggregate revenues are $100*N and aggregate costs are $10*N. That means aggregate profit will be $90*N. The aggregate RATE of profit is the profit divided by capital invested, which is $90*N / $10*N = 900% (yes, that rate is huge, but the number doesn’t actually matter for the purposes of this discussion)."

     "Here is where the rate of interest comes in. If the aggregate rate of profit on capital invested is 900%, then what will tend to occur is that anyone who wants to “part with their liquidity” for investment purposes, will have two investment choices. Either they can invest the money themselves and try to earn the 900% average profit, or they can loan it to others who will then invest it and try to earn the 900% average profit."

    "The supply of loanable funds, no matter what the quantity (in the first economy it is $10*N maximum supply), will tend to carry an interest rate of around 900%. This is because if an investor can earn 900% on his money, then should he loan the money to someone else instead, he’ll want to ask for a 900% interest rate and he will tend to get it as well. If any borrower offers him less than 900% interest, then the investor can just take his money and invest it directly himself and try to get the 900% profit. In order to induce him to “part with his liquidity”, the borrower will have to offer him an interest rate of around 900%."

     "Now let’s look at the second economy.

      "In the second economy, aggregate investment is $100*N and aggregate consumption is $900*N (N = number of individuals). This means that out of all money received through sales (labor, goods, etc), which is ($100 + $900)*N = $1000*N, there will be $100*N that will show up as business costs (ignore depreciation and assume for simplicity that the $100*N capital invested each year is used up each year) and $1000*N will show up as revenues."

     "Here, the “natural” profit in the first economy will be the difference between aggregate revenues and aggregate costs. Aggregate revenues are $1000*N and aggregate costs are $100*N. That means aggregate profit will be $900*N. The aggregate RATE of profit is the profit divided by capital invested, which is $900*N / $100*N = 900%. Notice something familiar?"

     "The supply of loanable funds, (in the second economy it is $100*N maximum supply), will tend to carry an interest rate of around 900%. This is again because if an investor can earn 900% on his money, then should he loan the money to someone else instead, he’ll want to ask for a 900% interest rate and he will tend to get it as well. If any borrower offers him less than 900% interest, then the investor can just take his money and invest it directly himself and try to get the 900% profit. In order to induce him to “part with his liquidity”, the borrower will have to offer him an interest rate of around 900%."

     "The error that Keynes made was to fallaciously assume that when people “part with liquidity”, it only goes to investment. If parting with liquidity, i.e. giving up cash, i.e. trading using money, only went to investment, then yes, it is possible to conceive of the rate of interest as determined by liquidity preference. But when people part with their money, they can either invest it or consume with it. THAT DIFFERENCE between investment and consumption is what generates profit in the economy, it is what generates a difference between what business spends on factors and what they receive in revenues, and it is what generates nominal interest rates on loans."

     "Mises called the 900% aggregate rate of profit, that I showed above, as “originary interest.” This difference is monetary as in your dissertation Bob, that is, the difference between money out and money in, or exchange rate between current dollars and future dollars, and, most importantly, this difference is determined by time preference, not liquidity preference."

      http://consultingbyrpm.com/blog/2011/07/is-keynes-from-heaven-or-hell.html

     Got it? I know, if you're not used to him the first thing that catches the eye is how goddamn much he writes. But this is the most funky idea of what generates profits in the economy I've ever heard: the difference between investment and consumption. 

     And these strange examples he comes up with where in every possible incantation we get a 900% profit. I thought Sumner had a confusing definition of saving, investment, and consumption. But Major again takes us to new uncharted waters of strange. Maybe this is how economics is taught on his planet.

    I again stand by what've I've told him. The reason he wont tell us what school he got the economics degree he claims he has is because the school has a restraining order against him every telling anyone where he got it from. It was Fine here's your degree just get out of our classroom. You can have your PHD as long as no one ever knows you got it here.

   Of course Major as is his wont. insists on measuring everything by individuals first. He can't just say there was $400 billion of consumption he's got to list X amount of individuals per $10 each. Truly Bizzaroworld economics.

    Murphy for his part had this to say about this whole spiel:

    "MF, I’m just being honest with you here, I come to my blog when I’m taking a break from “real work.” Your posts are too long for me to even read, because I know it would take me longer than the 5 minutes I want to devote to the break. So that’s why I don’t grapple with you often (esp. on the Sunday posts). If you have 18 reasons that I’m wrong, just post the top 2."