Hülsmann on the Economics of Deflation

The Ethics of Money Production
by Jörg Guido Hülsmann

Chapter 3: Money within the Market Process

3. DISTRIBUTION EFFECTS

This way of presenting things is not fully correct. It is true that an increased money supply tends to bring about higher money prices, and thus diminishes the purchasing power of each unit of money. But it is not true that this process necessarily operates in favor of the debtor and to the detriment of the creditor. A creditor may not be harmed at all by a 25 percent decrease in the purchasing power of money if he has anticipated this event at the point of time when he lent the money. Suppose he wished to obtain a return of 5 percent on the capital he lent, and that he anticipated the 25 percent depreciation of the purchasing power; then he would be willing to lend his money only for 30 percent, so as to compensate him for the loss of purchasing power. In economics, this compensation is called “price premium” — meaning a premium being paid on top of the “pure” interest rate for the anticipated increase of money prices. This is exactly what can be observed at those times and places where money depreciation is very high. 3

3 Late scholastic Martín de Azpilcueta argued that price premiums were not per se usurious, but legitimate compensations for loss of value. See Martín de Azpilcueta, “Commentary on the Resolution of Money,” Journal of Markets and Morality 7, no. 1 (2004) §48–50, pp. 80–83.

A creditor might actually benefit from lending money even though the purchasing power declines. In our above example, this would be so if the depreciation turned out to be 15 percent, rather than the 25 percent he had expected. In this case, the 30 percent interest he is being paid by his debtor contains three components: (1) a 5 percent pure interest rate, (2) a 15 percent price premium that compensates him for the depreciation, and (3) a 10 percent “profit.”

The same observations can be made, mutatis mutandis, for the debtors. They do not necessarily benefit from a depreciating purchasing power of money, and they can even earn a “profit” when money’s purchasing power increases if the increase turns out to be less than that on which the contractual interest rate was based. It all depends on the correctness of their expectations.

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The Myth of ‘Involuntary Unemployment’

Since layoff is necessary to allow obsolete firms to decline or disappear in favor of new firms that tend to conform to the changes of individual preferences, a frictional unemployment emerges.

Obviously, unemployment caused by regulations (e.g., minimum wage, unemployment benefits, labor unions) is considered as involuntary unemployment. Economists do not deny this. But some still subscribe to the idea that frictional unemployment could be labelled involuntary unemployment as well.

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