James Ahiakpor writes: " bank deposits originate from the public's desire to
place their non-consumed incomes with such institutions."

I think I learned from Lloyd Mints that the original banks in the English
colonies issued bank notes, and stood behind them, secured by the collateral
the borrowers had pledged.  Only later did the banks begin accepting
deposits from savers.  Is this not still the standard view?  If not, please
disabuse me.

Mason Gaffney

-----Original Message-----
From: Societies for the History of Economics [mailto:[log in to unmask]] On
Behalf Of James Ahiakpor
Sent: Saturday, February 27, 2016 11:32 PM
To: [log in to unmask]
Subject: Re: [SHOE] Is there a history of cost-push or wage-price spiral
analysis?

Sadly, Roger Sandilands keeps repeating what he's learned from Lauchlin
Currie's monetary analysis.  Alas, Currie made little meaning of "credit,"
even suggesting in chapter 5 of his 1935 book, /The Supply and Control of
Money in the United States/, that we limit the term "credit" 
to "demand deposits and to discountenance any other use."  To Currie,
"money" must include credit or demand deposits.  But this is contrary to the
classical definition of money and its monetary analysis. Moreover, Currie
was heavily influenced by Keynes's monetary analysis, rather than that of
Hume, Smith, Ricardo, and J.S. Mill.  Ricardo and Thornton well explained
that, in the case of bank panic, there is never a sufficient amount of a
central bank's notes to satisfy the public's demand for them and to prevent
the price level from falling.

What Currie (and Sandilands) fail to recognize is that bank deposits
originate from the public's desire to place their non-consumed incomes with
such institutions.  Thus, no central bank can control their volume.  And in
the nature of fractional-reserve banking, where the banks commit the
public's deposits to acquiring longer-dated assets than the duration of
their liabilities, the banks have little other recourse than borrowing from
a central bank -- the origin of fiat money.  That's why a "Discount Window"
exits.


Roger Sandilands wrote:
> Per contra James Ahiakpor, I think it is transparently obvious that the
Fed failed in its classical duty to be a proper lender of last resort during
the Great Depression. Just because it accommodated the public's increased
preference for cash rather than bank deposits does not gainsay this.
>
> What happened is that in order to meet the public's demand for cash, the
banks were forced to borrow from the Fed. And because the Fed did so little
to relieve the banks of their consequential indebtedness, many of them
closed and the survivors' repugnance to debt led them to contract their own
lending. The result was a one-third decline in the community's total means
of payment - defined sensibly as cash plus bank deposits subject to transfer
by cheque to make payments every bit as effectively as if they were using
notes and coin [and properly excluding bank reserves not in circulation from
a sensible definition of money].
>
> Is James seriously suggesting that if the public had $2bn more cash but
$4bn less in the banks, they would feel they had just as much money as
before? That they would feel the Fed was doing its job properly? And that
they would not be inclined - or forced - to reduce their spending? And that
if the banks remained heavily in debt they too would continue to lend as
before to maintain the community's circular flow of income?

I also find little meaning in the claim that banks find borrowing repugnant.
The business of banking is that of financial intermediation
-- borrowing from savers to lend  to borrowers!  And when the Fed expanded
its liabilities by 25% between 1930 and 1933, I find the claim that it
failed to relieve banks of their indebtedness not very meaningful.  I
suggest that Roger study Ricardo (1: 358-59) and Thornton (1802, 197) on the
capability of a central bank to meet the needs of the public for currency in
a panic.  The public chooses how much of its non-consumed income it places
with banks and how much it holds in cash.  
When the public holds cash, it reduces spending.  When funds are placed on
deposit, the banks lend most of them to their borrowing clients who spend
them.

> Even Mill (Principles, 3, XI, para 2) agreed that the maintenance of a
flow of "credit" - by which he meant "money substitutes" in the form of bank
deposits that were means of payment - was indispensible in "making a
corresponding addition to the aggregate production of the community".

See my explanation above.  Savings -- the acquisition of bank deposits and
other financial assets -- transfer savers' non-consumed income to borrowers,
most of whom spend such funds productively. There is nothing novel in Mill's
statement above; it's standard classical analysis.  
Contrast with Keynes's treatment of the role of saving in the process of
economic growth!
>
> On this criterion, the Fed was grossly delinquent. As Lauchlin Currie
wrote in The Supply and Control of Money in the United States (Harvard 1934:
146-47):
>      "Much of the current belief in the powerlessness of the reserve 
> banks appears to arise from a complete misreading of the monetary 
> history of 1929-32. It is generally held that the reserve 
> administration strove energetically to bring about expansion 
> throughout the depression but that contraction continued despite its 
> efforts. Actually the reserve administration's policy was one of 
> almost complete passivity and quiescence." [Cited in David Laidler, 
> Fabricating the Keynesian Revolution, 1999: 236]

Yeah, yeah, I heard this declaration several times before.  It misrepresents
what happened.
>
> But James asks: "So wherein lies the validity of the claim that the Fed
failed to act as a lender of last resort?"
>
> The answer: Only by defining and monitoring money in the narrow sense of
currency - and also by treating non-circulating bank reserves as money. And
also, I would add, by treating interest-bearing time (savings) deposits as
though they have the same economic effect on the circular flow as
non-interest-bearing demand (transactions) deposits held for differing
motives, hence differing turnovers.
>
> With a one-third drop in the money supply, prices also fell drastically.
And faster than did money wages. So real wages of those in employment rose.
Ah, so it was the workers who were to blame for the Depression??

The price level fell because of the increased demand for money (cash) in
excess of its supply.  That derives directly from a correct interpretation
of the classical Quantity Theory of Money. The base money increased by 25%,
from $4 billion to $5 billion.  The $8 billion contraction in bank deposits
represents a greater increase in money's demand than the supply.  When the
price deflation ended in 1934, it was not because the base money had
increased by an additional $8 billion!

The classical forced saving doctrine also explains that, because of the
lagged adjustment of nominal wage rates, an increase in the supply of money
in excess of its demand causes prices to rise, real wages to fall, and
increases the hiring of more workers in the short run.  In the opposite, an
increased demand for money (currency) in excess of its supply causes prices
to fall, real wage rates to rise, and an increase in the rate of
unemployment.  This analysis was well known to the early neoclassical
monetary analysts, including  Alfred Marshall, Irving Fisher, Frank Taussig,
and R.G. Hawtrey.  Keynes didn't think "forced saving" was a meaningful
concept or analysis. I don't know whoever blamed workers for the Depression.

>
> As a postscript, one of those who thought this way was Harvard's Joseph
Schumpeter. Lauchlin Currie (who was Schumpeter's teaching assistant) told
me that JAS's sole anti-depression policy prescription was to favour wage
cuts - for Harvard's tea ladies, not for the faculty whose real incomes
therefore rose. This accorded, said Currie acerbically, with his belief that
"a gentleman cannot live on less than $50,000 a year."

As I have noted in my 2010 /HOPE/ (p. 565, n. 15) article critiquing David
Laidler and Roger Sandilands's treatment of Currie's monetary analysis,
Joseph Schumpeter was no good representative of classical monetary analysis.
In fact, much of the limited appreciation of classical monetary analysis in
modern times can be traced to Schumpeter's poor representation of what the
classics wrote in his /History of Economic Analysis/.

James Ahiakpor
> - Roger Sandilands
> --------------------------
> James Ahiakor wrote:
>     I tried very much to avoid getting into this discussion, but I
couldn't resist because of Tom Humphrey's latest contribution.  He employs
our modern (Keynesian) definition of money and "money stock" to interpret
Henry Thornton's monetary analysis along the lines of Milton Friedman.  It
is misleading.  He argues:
>
> So I guess Thornton did indeed anticipate bank failure and money stock
contraction resulting from the Fed's failure to act as a lender of last
resort in the Great Depression of the 1930s.
>
> Thornton (1802, 90), along with the other classics, including David Hume,
Adam Smith, and David Ricardo, defined money as specie and banknotes as
money substitutes or "paper credit."   The notion of "the money stock," be
it M1 or M2, is not to be found in their works.  M1 and M2 include the
public's "savings," be they the regular savings deposits or checkable
deposits.  The Fed did expand its liabilities (notes) by about 25%, from $4
billion to $5 billion between 1930 and 1933 (Irving Fisher 1935); Friedman
and Anna Schwartz (1963, 24-29) also report that currency in circulation
rose from $3.78 billion in January 1930 to $5.57 billion by March 1933.   So
wherein lies the validity of the claim that the Fed failed to act as a
lender of last resort during the Great Depression?   From where did the
money, properly so called, arise for the public to hold its additional
quantity?  Perhaps, it is noteworthy that Friedman (1960, 88-89) also
acknowledges that "Under present circumstances, even the stock of money is
not directly controlled by the [Federal Reserve] System.  The System
controls directly its own earning assets."
>
> As for the wage-price spiral argument, it belongs firmly with Keynes and
his followers, just as Richard Lipsey has noted.  It is all in Keynes's
tradition of rejecting the classical quantity theory of money as the
explanation of the price level and its changes.  In the classical analysis,
an increase in nominal wage rates does not by itself raise the price level.
That would rather put pressure on profits.  Thus, following David Ricardo's
explanation of that mechanism, J.S. Mill chides those who would argue
otherwise, noting:
> "There is no mode in which capitalists can compensate themselves for a
high cost of labour, through any action on values or prices.  It cannot be
prevented from taking its effect on low profits" (3: 479).  Mill (3: 699;
italics added) further explains:
>
> "The doctrine, indeed, that a rise of wages causes an equivalent rise of
prices, is, . self-contradictory: for if it did so, it would not be a rise
of wages; the labourer would get no more of any commodity than he had
before, let his money wages rise ever so much; a rise of real wages would be
an impossibility.  This being equally contrary to reason and to fact, it is
evident that a rise of money wages does not raise prices; that high wages
are not a cause of high prices.  A rise of general wages falls on profits.
There is no possible alternative."
>
> What von Mises should have argued regarding unions raising wage rates is
this: Unions may succeed in raising the (nominal) wage rates of their
members, but that may also lower the wage rates of non-unionized workers
because of the increased rate of unemployment that would result from the
raised union wages.    Mises's argument is one of the unfortunate results of
some Austrians' disputing classical monetary analysis.
>
> James Ahiakpor
>
> On 2/26/2016 7:06 AM, Thomas Humphrey wrote:
> Robert,
>
> Henry Thornton in 1802 obviously could not anticipate all the events 
> of the Great Depression that happened 128 years after he wrote. And he 
> most certainly did not postulate a downward wage-price spiral in his 
> analysis, which can be found on pp. 118-19 of the standard Hayek 
> edition of his (Thornton's) Enquiry Into the Nature and Effects of the 
> Paper Credit of Great Britain. Instead, Thornton said that a one-time 
> fall in prices would result from a monetary contraction. But nominal 
> wages would remain unchanged. Nominal wages would remain unchanged 
> because workers would interpret the price fall as being temporary 
> (albeit perhaps for a protracted period of time), and would anticipate 
> a later reflation of the price level. (Why lower wages in the face of 
> a price fall anticipated to be temporary and subsequently reversed?)
>
> Thornton was arguing that conventional domestic monetary contraction might
not be the best way to deal with a balance-of-payments deficit and resulting
outflow of gold. For the monetary contraction would, by causing a price fall
which in the face of sticky nominal wages would produce rising real wages,
lead to a fall in real output and employment in all sectors, including the
export sector, of the economy. And depression in the export sector, Thornton
held, was hardly the best way to correct the balance-of-payments deficit
causing the gold outflow.
>
> Thornton applied that same reasoning to argue that monetary expansion, not
contraction, was the proper way to handle financial crises and panics when
the demand for base money was increasing as bank depositors sought to
convert deposits and notes into coin and bankers sought increases in their
reserve/deposit ratios. Without monetary expansion to meet the increased
monetary demand, the result would be monetary contraction, price falls,
rising real wages, layoffs, and falling real activity. In this way,
recession would follow from financial panics. Bank failures would also
occur. So I guess Thornton did indeed anticipate bank failure and money
stock contraction resulting from the Fed's failure to act as a lender of
last resort in the Great Depression of the 1930s. But, to reiterate, he did
not anticipate the concept of a downward wage-price spiral. Instead he
postulated a one-time rise of real wages owing to the fall of prices in the
face of unchanged nominal wages. One must look elsewhere for the origins of
the "spiral" idea.
> --Tom Humphrey


--
James C.W. Ahiakpor, Ph.D.
Professor
Department of Economics
California State University, East Bay
Hayward, CA 94542
510-885-3137
510-885-7175 (Fax; Not Private)