Understanding Cash Mechanics
by Robert P. Murphy
Mises Institute, 2021, 210 pp.
Robert Murphy intends to provide the “smart layperson a succinct yet comprehensive summary of the theory, history, and practice of cash and banking, with a focus on the United States” (p. 9), and he is successful in doing so, but I do not propose here to focus on this introduction. In the course of his “neutral discussion” of it, he makes a variety of valuable points about Austrian theory and the American economy, and his immense talent for the clarifying analogy is all over to the fore. In what follows, I will endeavor to explain a few of these points.
Calls to “End the Fed” have been going on for a very long time, and a lot of us have with terrific enthusiasm supported Ron Paul in difficult federal control of our monetary system; however, Murphy says, over the last few years the threat from the Fed has actually worsened than in the past. No longer does the Fed confine itself to trying to determine the economy’s monetary framework, but it now chooses particular companies in which to invest. By selecting winners and losers in this way, it has actually arrogated to itself unapproved power. As Murphy states,
In order to avoid the obvious invite to corruption, the legislation licensing the Federal Reserve put limits on what the US central bank could purchase. After all, if individuals running the New York Federal Reserve Bank [who supervise of asset purchases] could develop cash electronically with which to buy particular shares of Wall Street stock, there would be huge chances for abuse … In practice, the Fed lent cash to freshly developed Limited Liability Corporations (LLCs) called “Maiden Lane”– referring to the street in New york city’s monetary district– that would then use the money obtained from the Fed to buy the wanted possessions. (p. 90)
In his discussion of the Austrian theory of the business cycle (ABCT), Murphy calls attention to something rarely highlighted by other authors. As the theory is typically represented, the cycle begins when the reserve bank broadens bank credit, causing a drop in the loan interest rate, which creates an artificial boom. The central bank can do this just when at least a really considerable part of the money supply consists of fiat money, i.e., money not backed by a product such as gold. For that reason, critics of the ABCT say, the theory can not discuss business cycles that occurred before the onset of contemporary main banking.
Not so, states Murphy, and for 2 reasons. First, “the Austrian theory of business cycle isn’t based upon fiat money. Indeed, Ludwig von Mises developed his description of the boom-bust cycle at a time when he didn’t even believe fiat money had actually ever been in usage. So plainly, the Misesian theory of economic crises isn’t straight connected to the abandonment of the gold requirement, and it’s therefore not a problem for Austrians to describe depressions (or ‘panics’) that took place during the days of the classical gold standard” (p. 105).
Second, the ABCT isn’t based on the existence of a reserve bank, however rather on fractional reserve banking.
But there is no doubt that Mises’s theory of business cycle is based upon the capability of the personal commercial banks to produce money through the issuance of new loans utilizing deposits that the depositors still think are in their checking accounts. It holds true that central banks can influence these commercial bank practices in a damaging way, however the Misesian theory isn’t about central banks (or fiat money) per se …when contemporary fans of Mises talk about business cycle, they need to beware to avoid claiming that it always begins with a reserve bank injecting brand-new fiat money into the economy. (p. 107)
Murphy goes on to discuss why booms can not be permanently sustained: the physical resources are not present to bring to conclusion all the investments brought about by reducing the interest rate on loans through the expansion of bank credit.
Imagine a contractor working on a home. Thinking he has a certain amount of materials– bricks, wood, glass, shingles, etc– at his disposal, he draws up plans and appoints different proficient and inexperienced employees to their tasks. But suppose that the contractor had overestimated the number of bricks he initially had. In that case, your home depicted in his plans would be physically unsustainable. The moment the contractor recognized his error– simply put, when he understood that his real supply of staying bricks was smaller sized than what his plans required– his instant reaction would be to inform everybody on the work site to halt! (pp. 110– 11)
Keynesians have a widely known objection to the master-builder argument. They state that it presumes that resources are fully employed. If they aren’t, the boom can be sustained due to the fact that credit growth will bring unused resources into production. As you may expect, Murphy isn’t convinced. Keynesians have no explanation for the existence of idle capability. By contrast, “according to Mises’s theory of the business cycle, the existence of ‘idle capability’ in the economy does not just fall out of the sky, however is instead the result of malinvestments made throughout the preceding boom” (p. 194). He further keeps in mind that their view stops working to represent the historical truths. “Empirically, we keep in mind that throughout the 1930s, federal governments and reserve banks all over the world participated in the most Keynesian policies in history to that time … the Federal Reserve in the early 1930s expanded the monetary base and slashed the interest rates to then record lows” (pp. 163– 64). These policies stopped working to restore success. Doesn’t this falsify the Keynesian account? Keynes did not claim that his theory was an a priori reality, so it would not be an excellent answer for Keynesians to pull away in the face of failure of the logical credibility of their theory.
They do have another response, however. They state that the federal government did not spend adequate and this was the factor the Great Anxiety continued throughout the 1930s. Murphy asks a devastating concern:
If the fundamental Keynesian explanation for the Great Anxiety is that governments were too shy when it pertained to budget deficit, then why didn’t the Great Anxiety occur earlier, when everyone confesses that government did even less during monetary panics? No, a far more practical explanation of the historic record is looking us in the face: the depressions (or “panics”) of the nineteenth and earlier twentieth centuries played out according to the theory developed by Ludwig von Mises. Yet throughout these crises, governments mainly remained aloof, which’s why the economy recovered. (p. 164)
Keynesians are not the only economic experts who oppose the ABCT, and Murphy addresses a number of the completing accounts. In his comments on Scott Sumner’s argument that the financial policy of the Fed must be examined by whether the development rate of nominal gross domestic product has increased by what he considers the proper quantity, Murphy shows the gift for the apt analogy which I pointed out at the start of this review. He says that given that “the Fed permitted NGDP development to (ultimately) collapse, Sumner argues that by definition this is a ‘tight’ central bank policy” (p. 174). Murphy items that this definition makes it difficult to reveal that Sumner’s policy advice is incorrect.
Think about a medical analogy: expect a patient is suffering from fever, running a temperature of 103 degrees. One group of medical professionals suggests injecting the patient with substance M, in order to cure the fever … Certainly, picture if the doctors who believe that compound M is a helpful medicine wanted to specify the M treatment in terms of the fever. That is, if after they had actually injected the patient with unprecedented amounts of M, whether the fever had remained the very same or gone up, the medical professionals declared, “We just made the patient sicker with our shift to restrict the M treatment.” This would be Orwellian and undoubtedly would make it practically impossible to figure out whether more or less M was what the patient needed. (pp. 174– 75)
Murphy has no usage for modern-day monetary theory (MMT) either, and I’ll conclude with his discuss the notion held by many members of the school that cash didn’t stem as a product but rather by the government’s statement that taxes needed to be paid in a new financial unit. “The only issue [with this theory] is that it’s demonstrably false … The MMT explanation of where cash comes from doesn’t apply to the dollar, the euro, the yen, the pound … Come to consider it, I do not think the MMT explanation uses even to a single currency provided by a financial sovereign” (p. 200).
Understanding Money Mechanics is an impressive book, and readers of it will gain much from the insights of its skilled and erudite author.