Animal Spirits Pt. 3: Natural Wage Theory, Money Illusion, and Wages

I just finished reading Chapter 9 of Animal Spirits. Now I see the point of criticizing Natural Rate Theory. I mentioned in an earlier installment that I suspect that, over the long time, wages will tend to track inflation, but lag behind. Akerlof and Shiller appear to be saying that this is precisely the point. Steady inflation holds wages at a lower level, one which allows a lower level of unemployment. Employers can grant employees raises for the financial purpose of keeping it in line with the purchasing power of money, while still giving the employee the feeling that they are being rewarded for their efforts. In the absence of inflation, the employer can't afford to give so many raises, the employee feels he's not being treated fairly, and worker productivity falters. So, in their analysis, because of money illusion and fairness, a certain level of inflation is required to keep productivity up.

Outside factors they failed to take into account (which I will get into below), I can find no fault with their analysis. Particularly in a world in which people have, over multiple generations, come to regard raises as a regular obligation, perceived unfairness (that very phrase is redundant, given all fairness is subjective) could well result in productivity losses in the absence of inflation-motivated raises.

Of course, this likely leads to the recommendation that a level of inflation should be maintained at all times. Further, it makes something like a commodity money seem untenable. However, there is something else to put into the analysis: the credit cycle. Wages are downwardly rigid, therefore deflation can damage employment levels, as falls in wages fail to keep pace with falls in other prices. But what if "fractional reserve" banking were abolished, and therefore the bank created inflation that ultimately leads to deflation never occurred in the first place? The downward rigidity of wages could become irrelevant, in this scenario. But then, it could also lead to an extended (possibly multigenerational, meaning it would be politically unsustainable in reality) period of adjustment, until people finally realized psychological satisfaction is not going to come from making the numbers bigger.

It's a big hurdle to get over. From a strictly logical standpoint, wages generally rising over time, but lagging behind prices is not as good for workers as wages falling slowly but lagging behind prices. But falling prices, though it is good for a person whose wages have not yet fallen, is an impersonal phenomenon. Rising wages, though, feel like a personal reward, even if the employer is only keeping the wage in line with rising prices, and even lagging behind. The gradual price drops of a stable money supply may be better for workers materially, but rising wages, even insufficient to cover rising prices, are more emotionally satisfying.

Were it not for the dangers inherent in a fiat token-based (whether paper or digital) currency (which we are seeing today, as the results of bad monetary policy hit the economy like a hurricane), a fiat currency would definitely be better... IF the money supply expanded evenly. Unfortunately for fiat money supporters, it does not. Industries grow beyond what they should because of investment bubbles, and then people lose their savings, workers lose time building knowledge and experience in bad industries (not to mention their jobs for no good reason), people lose confidence (which the authors just spent a chapter talking about). I'm presently convinced the negatives of fiat money and an inflationary policy outweigh the negatives.

That, and I have moral difficulties with the idea of a monetary elite making things better by deliberately deceiving laborers.

Gold: Theoretical Nexus between Austrian and Geoist Economics

Lately, I've been paying a lot of attention to the work of Dr. Michael Hudson, whom I discovered via his many interviews on Guns and Butter, a radio show I used to listen to regularly via KFCF. (It's a shame my newly local WPFW doesn't carry that show.) A theory that is somewhat new to me that I've encountered via his work concerns taxation as the source of money value. Initially odious to a libertarian thinker like myself, some thought about the role gold typically plays has lead me to believe there might be some truth to the notion.

I wish I could point you to a definitive page outlining this theory. I'm pretty sure it's at least related to the Fiscal Theory of Price Level (the wikipedia article could use some development, but it's the best introductory link I could find, the others being equation-heavy and highly technical papers from various Federal Reserve Banks). But the basic idea I'm so recently exposed to is that money derives its value from the demand for it created by its acceptance to satisfy tax liabilities.

This contrasts with the theory I'm most accustomed to, which is a simple question of supply and demand with its utility being a question of its durability, divisibility, and scarcity, and general acceptance in payment for other goods. Durability: How long can it be stored before it degrades? Divisibility: Can I make change? Scarcity: How much value can I store in how little space? Acceptance: Will anybody care that I have this? Gold fits all four of these. It doesn't generally oxidize, nor does it shatter, you can divide it down to tiny grains without reducing its "goldness" one bit, it is rare enough that one could potentially buy, for example, a car, for an amount of gold that could be carried in a small sack. So then the question arises: where does its initial demand come from? Why would anybody want gold?

The answer is obvious: the stuff looks good, and unlike other things that look like gold but aren't, it will continue to look good pretty well indefinitely. It makes an excellent decoration. There is always somebody who is willing to accept it in payment. The question then becomes: who? And in payment for what?

The short answer is "the rich", the richer the person is, the more gold they are (were?) likely to make use of, relative to their use of everything else. A middle class person might hold a few important pieces of jewelry (such as a wedding band), but a rich person might have many otherwise common items either constructred from or plated with gold. In other words, he'll use more. But who is likely to be rich?

These days, we like to focus on the successful entrepreneur: the Bill Gates' of the world. And yes, it is true that the richest tend to be those whose efforts have produced new tools, products, processes, and so on. But this has not always been the case historically, and even today, below the super rich "new money" types you have "old money", who largely collect their wealth in the form of rents.

"Rent" is nothing more than money received for access to an opportunity or good in excess of the resources actually needed to enable access to it in the first place. Land is the primary example, the cost of making it available being the cost of securing exclusive access (basically the protection of capital improvements against thieves, vandals, etc.), and economic rent being the amount actually received in exchange for access minus that cost. Those who are in the business of collecting rents will tend to be richer than those who pay them, and those who are rich by other means will tend to "invest" their newly earned wealth in rent collecting opportunities (adding their descendants to the existing aristocracy).

We now have a reason gold is always acceptable in payment for goods: it is always acceptable in payment for rent, due to the fact that the rent collectors are also the ones who have the most use for gold other than as a medium of exchange. If the gold supply becomes excessive (as can happen after a large discovery), the rent-collecting class will tend to absorb the excess in the form of luxary goods. This, then, ensures that there is always a demand for gold, making it acceptable at nearly all levels of society as a medium of exchange. You can't eat gold, but you can pay rent with it.

If one considers rent to be a "tax" of sorts (and I do), then what you have is gold satisfying the "tax value" theory of money value (or whatever its called), and it does so naturally, without the intervention of legislative declaration, monetary "policy", or even a functioning government.