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The phenomenon of inflation is still puzzling, isn't it? The "common sense" theory (that flush of money diminishes value of money tokens with respect to existing goods) implies a closed-market mechanism. A larger amount of money, especially if it comes from higher wages, leads to more intense consumer competition and hence to higher prices - or so they say.

Yet I do not see this mechanism working consistently. Say, take the Baltic countries: they experienced a credit boom in this decade, which increased their nominal wealth and monetary volume enormously - yet the prices did not rose at the height of the boom. Consumers were never more potent then, as realistic worries of debt return were non-existent. Why did entrepreneurs did not raise prices then?

Inflation did rose there on the last months of the boom, when indeed wages started to raise. But how did entrepreneurs reacted so fast to presumably more potent consumer demand? I do not see how consumers had a chance to clash "competitively" so fast. Rather, a much simpler explanation is that entrepreneurs "routinely" included raising costs (of higher wages) into the higher prices, trying to keep their profit share.

If you look at the Weimar Republic, the outside pressure of investors (with utmost skepticism regarding war debts and reparations) was clearly a factor. In a closed economy, the Germans could just as well use Worgl type currency. In contrast, the Nazi Germany largely bypassed control of international financial system and issued "very strange" paper money quite liberally - with remarkable (though inconvenient, controversial?) economic results at the times of Great Depression.

I even speculate that the Spanish inflation (after they got their mountains of silver and gold, as I mentioned) was wishfully fueled by the other financial powers that could not recognize such a large gap in monetary power. The strong money-as-credit association is very much Anglo-Saxan innovation.

by das monde on Wed Sep 2nd, 2009 at 07:13:31 AM EST
Web of Debt - Thinking Outside The Box: How A Bankrupt Germany Solved Its Infrastructure Problems
Schacht actually disapproved of this government fiat money, and wound up getting fired as head of the Reichsbank when he refused to issue it (something that may have saved him at the Nuremberg trials). But he acknowledged in his later memoirs that allowing the government to issue the money it needed had not produced the price inflation predicted by classical economic theory. He surmised that this was because factories were sitting idle and people were unemployed. In this he agreed with John Maynard Keynes: when the resources were available to increase productivity, adding new money to the economy did not increase prices; it increased goods and services. Supply and demand increased together, leaving prices unaffected.
Fascinating...

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Wed Sep 2nd, 2009 at 07:27:13 AM EST
[ Parent ]
according to John Kenneth Galbraith:
     By the mid thirties there was also in existence an advanced demonstration of the Keynesian system.  This was the economic policy of Adolf Hitler and the Third Reich.  It involved large-scale borrowing for public expenditures, and at first this was principally for civilian works -- railroads, canals and the Autobahnen.  The result was a far more effective attack on unemployment than in any other industrial city.16 By 1935, German unemployment was minimal.  'Hitler had already found how to cure unemployment before Keynes had finished explaining why it occurred.'17  In 1936, as prices and wages came under upward pressure, Hitler took the further step of combining an expansive employment policy with comprehensive price controls.
      The Nazi economic policy, it should be noted, was an ad hoc response to what seemed over-riding circumstance.  The unemployment position was desperate.  So money was borrowed and people put to work.  When rising wages and prices threatened price stability, a price ceiling was imposed.  Although there had been much discussion of such policy in pre-Hitler Germany, it seems doubtful if it was highly influential.  Hitler and his cohorts were not a bookish lot.  Nevertheless the elimination of unemployment in Germany during the Great Depression without inflation -- and with initial reliance on essentially civilian activities -- was a signal accomplishment.  It has rarely been praised and not much remarked.  The notion that Hitler could do no good extends to his economics as it does, more plausibly, to all else.

      Thus the effect of The General Theory was to legitimatize ideas that were in circulation.  What had been the aberrations of cranks and crackpots became now respectable scholarly discussion.  To suggest that there might be over-saving now no longer cost a man his degree or, necessarily, his promotion.  That the proper remedy for over-saving was public spending financed by borrowing was henceforth a fit topic for discussion -- although it continued to provoke bitter rebuke.  The way was now open for public action.

  1. '... the Nazies were ... more successful in curing the economic ills of the 1930s [than the United States].  They reduced unemployment and stimulated industrial production faster than than the Americans did and, considering their resources, handled their monetary and trade problems more successfully, certainly more imaginatively.  This was partly because the Nazis employed deficit financing on a larger scale ... By 1936 the depression was substantially over in Germany, far from finished in the United State.' John A. Garraty, 'The New Deal, National Socialism, and the Great Depression' American Historical Review, vol. 78, no. 4 (October 1973), p. 944.

  2. Joan Robinson. Quoted by Garvy.

_______

John Kenneth Galbraith, "The Coming of J.M. Keynes", Money: Whence It Came, Where It Went (1975), pp. 237-239

So he does qualify the Nazi achievement as "the elimination of unemployment in Germany during the Great Depression without inflation", but this was done through the use of price controls, which seems like cheating to me (though to Galbraith, who served as deputy head of the [U.S.] Office of Price Administration during World War II, price controls were a legitimate economic policy tool, if used judiciously in appropriate types of markets).

The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Wed Sep 2nd, 2009 at 09:44:43 AM EST
[ Parent ]
marco:
By 1935, German unemployment was minimal.  'Hitler had already found how to cure unemployment before Keynes had finished explaining why it occurred.'[Joan Robinson]  In 1936, as prices and wages came under upward pressure, Hitler took the further step of combining an expansive employment policy with comprehensive price controls.

...

... Nevertheless the elimination of unemployment in Germany during the Great Depression without inflation -- and with initial reliance on essentially civilian activities -- was a signal accomplishment.  It has rarely been praised and not much remarked.  The notion that Hitler could do no good extends to his economics as it does, more plausibly, to all else.

Oh, God, don't let the freepers find out or they'll start claiming that Keynes was a Nazi.

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Wed Sep 2nd, 2009 at 09:54:32 AM EST
[ Parent ]
marco:
this was done through the use of price controls, which seems like cheating to me (though to Galbraith, who served as deputy head of the [U.S.] Office of Price Administration during World War II, price controls were a legitimate economic policy tool, if used judiciously in appropriate types of markets)
Reading assignment: The New Industrial State wherein the mechanisms by which corporations control prices is elucidated, as well as the reasons why they do it. Having accepted that prices are controlled in a modern economy, why shouldn't they be controlled for the good of society? And, within Galbraith's analysis, since the "private" corporations are enmeshed in the institutional structure of society and its economy, isn't what is good for the corporations good for society and conversely?

En un viejo país ineficiente, algo así como España entre dos guerras civiles, poseer una casa y poca hacienda y memoria ninguna. -- Gil de Biedma
by Migeru (migeru at eurotrib dot com) on Thu Sep 3rd, 2009 at 10:20:02 AM EST
[ Parent ]
It is.

But - by definition - Nazi economic policy cannot have got anything right....

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Sep 2nd, 2009 at 10:11:40 AM EST
[ Parent ]
On the other hand, can we hear here a dog that did not bark?

What seems to be missing is pressure (or an attack) of international investors on the "funny" Nazi currency. It is not a big secret that, particularly, a portion of US political and financial establishment was rooting for Nazis.

by das monde on Wed Sep 2nd, 2009 at 10:56:35 PM EST
[ Parent ]
das monde:
A larger amount of money, especially if it comes from higher wages, leads to more intense consumer competition and hence to higher prices - or so they say.

How does that work? With the exception of essentials like housing, which seems to be a special case, can't consumers buy more stuff, and different kinds of stuff, rather than competing for the same stuff?

Rather, a much simpler explanation is that entrepreneurs "routinely" included raising costs (of higher wages) into the higher prices, trying to keep their profit share.

This seems rather more plausible.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Sep 2nd, 2009 at 09:18:51 AM EST
[ Parent ]
ThatBritGuy:
Rather, a much simpler explanation is that entrepreneurs "routinely" included raising costs (of higher wages) into the higher prices, trying to keep their profit share.

This seems rather more plausible.

But what compelled entrepreneurs to raise wages (in those 'the last months of the boom, when indeed wages started to raise')?

The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Wed Sep 2nd, 2009 at 09:53:28 AM EST
[ Parent ]
If an entrepreneur raises his prices - either because he can, (since he has pricing power), or because he must (since costs have risen) - is that not by definition "inflationary"?

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Wed Sep 2nd, 2009 at 10:15:03 AM EST
[ Parent ]
das monde and ThatBritGuy seem to be agreeing that the cause of inflation is entrepreneurs raising prices and blaming it on the increasing costs of rising wages they have to pay.

But das monde wrote that prices in the Baltics did not increase until the last months of the boom, which means (if I understood correctly) that wages did not rise until the last months of the boom either (even though expanded credit 'increased their nominal wealth and monetary volume enormously' -- I guess 'their' includes both entrepreneurs and workers).

So what I do not understand is what forced entrepreneurs, after a long period of not raising wages, to do so at the end of the boom like that?

The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Wed Sep 2nd, 2009 at 10:33:42 AM EST
[ Parent ]
what forced entrepreneurs, after a long period of not raising wages, to do so at the end of the boom like that?

Entrepreneurs really started to feel shortage in competent and reliable workforce. Economic emigration to the West was already in full force, and then the credit boom made the old wages laughably not worth working for.

There was also big disparity in wages: construction workers were paid very well (although the West were already in the West), while public workers like teachers were under-appreciated.

Wages in the Baltics were very stagnant because econoy through the 90s was still not good. In the beginning of 2000s, entrepreneurs were not raising wages unless they were "forced" to. Additional "envelope" (behind the counter) wage payments were also widespread.

by das monde on Wed Sep 2nd, 2009 at 10:10:27 PM EST
[ Parent ]
das monde:
Additional "envelope" (behind the counter) wage payments were also widespread.

A minor scandal erupted when it became clear that swedish banks had in the Baltics allowed people to borrow against their behind the counter income. Blew over quickly though.

Did any of the Baltic countries tax authorities crack down on this habit of behind the counter pay? That could also explain an increase in open wages.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Fri Sep 4th, 2009 at 07:14:07 AM EST
[ Parent ]
That's where both monetarist and Keynesian explanations of money are important (and Krugman's criticism of Ferguson is that Ferguson never shows that he really understands what either Keynes or Friedman was talking about).  

Keynes breakthrough in knowledge about money was to show that deflation occurs when values for bonds -- which he deemed like money in their ability to store wealth -- dropped precipitously, thus causing people dump their bond investments and demand hard currency.  Inflation is the opposite -- when bond investments increase in value people dump their currency holdings in order to hold bond investments.

Friedman's breakthrough was to generalize Keynes even further -- it wasn't just bond markets that determined demand for money, rather it was markets for all other assets.  Friedman showed this by adding stocks and bonds together to show the relationship between asset values and deflation or inflation, but the same idea can be extended to all other assets, including residential homes in the current crisis.  

If prices did not rise in the Balkans with expansion of credit there, it was likely because demand for non-currency assets was also high -- people were investing in real estate, construction, foreign investments, etc., and not trying to hold Balkan currency.

by santiago on Wed Sep 2nd, 2009 at 09:45:33 AM EST
[ Parent ]
In the book, Ferguson cites James Carville, when he was Bill Clinton's campaign manager:

"I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market: You can intimidate everybody."

Such is the power of financial democracy (or oligarchy?!).

I see a lot of subjective demand and supply in the modern economy and financial world - perceptions or anticipations, what the supplies and demands should be, or blind herd following of investment fashions or "best available" strategies. The two big theories do not apply well to bubble periods; they basically ignore relevance of bubbles. Regarding post-bubble depressions, I don't see how Friedman helps.

by das monde on Thu Sep 3rd, 2009 at 12:43:55 AM EST
[ Parent ]

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