Causality of Economic Cycles
(Theories)
Freedom of exchange merits constitutional status,
since its prices are the voice of the people
It is very dangerous to defend freedom based on “technomania”
Carlos A. Bondone
Buenos Aires, April, 2013
CARLOS A. BONDONE
Causality of Economic Cycles
(Theories)
Contents
Comparing cycle theories
Exchange→ prices causality
Alternative explanations of cycles
Comparative summary of cycle theories
Conclusion
Academic reflection
Notes
Causality of Economic Cycles
(Theories)
COMPARING CYCLE THEORIES
The issue that has always interested economists was the behavior of the human economy in society. This interest increased as society discovered indirect exchange —as a result of an increase in the generation of economic goods produced by specialization-division of labor— and currency as a means to make it more efficient, seeking to overcome the high cost of barter.
In turn, the adoption of different varieties of currencies —according to their type (money-credit) and nationalities— generated a renewed interest in the study of the behavior of individual’s economy in society. As a consequence, different currency-economic theories were developed to explain the phenomena that have been called economic cycles, considering as such the sharp variations of the behavior of individual’s economy in a society, especially concerning production and unemployment shocks.
Thus our concrete goal in this work is to present a comparison the theories the different schools of thought offer when they study the why, the how, the when, the where, the intensity, the duration, etc., of economic shocks.
For an effective comparison, we will recur to primitive concepts or terms considered by the whole of economic science and that are put into play in analysis. Ie, we will give special consideration to stressing the role the different theories assign to the theoretical basis, orientation that we believe has scientific grounding in so far as it allows us to judge the role economic theory has had in this fundamental issue. This is central considering the advent of TET —Theory of Economic Time— at the beginning of the twenty-first century, that questions the record of economic theory developed in the twentieth century.
In this work we consider the following schools of thought:
- Keynesians
- Monetarists-quantitativists
- Austrians that branch out into:
- Mises, in so far as his work can be considered a “compilation” of the foundations of post Menger thought in the twentieth century.(1)
- TET, in so far as it is a continuation —direct and with no intermediate steps— of Menger’s money theory. More specifically we refer to TET in the development of the Theory of Economic Time, Theory of Currency (Currency Theorem and its equality and equivalence axioms) and Interest Theory.(2)
The methodology for comparing the different theories will be referring to specific issues that are considered pertinent to economic cycles, and the stance of each school of thought, from the perspective of TET, in so far as:
1)The discovery of the Theory of Economic Time, with interest as its price, the relativity of both concepts (they have no life by themselves and always materialize in other economic goods), the permanent positivity of interest, the necessary presence as a production factor of all economic goods (and therefore their prices), necessarily redesign all aspects of economic theory —a concrete example: its Currency Theory and its equality and equivalence axioms.
2)It is the less known theory, on account of its brief period of existence (since the beginning of the twenty first-century).
Note: we ask that the persistent “self-references” present in this work be understood, considering that this is so because the issues presented have not been developed yet by other authors, which is understandable because of its “fresh” presentation in scientific society, and its radical change of focus based on causality (typical Mengerian framework).
With the stated goal, we present the following table, which summarizes issues and stances:
Table 1
Issues of Economic Cycles
And
Theoretical Stances
Issue / Keynesians / Monetar. / AustriansMises / TET
Say’s law / NO / YES / NO
Monetary causality / Supply → Need / Economic
Gresham’s law / YES / NO
Wicksell’s “virtual” currency / YES / NO
“Special” monetary theory / YES / NO
Emphasis on exchange / Indirect / Types
Monetary Regression Theorem / NO / YES / NO
Quantitative theory / YES / UNDECIDED / NO
Money ≡ Currency / YES / NO
Monetary reductionism / YES / NO
Currency functions / Traditional / New
Exogenous currency / YES / NO
Currency neutrality / UNDECIDED / NO
Interest as price of / Currency / Credit / Time
Types of credit / Unique / Regular-Irregular
Interest / (+) (-) (0) / (+)
Insufficient demand / YES / NO
Interest paradox / YES / NO
Currency insufficiency / YES / NO
Manipulation im / YES
Fractional currency financial causality / State-banking system → Market / Market → State – banking system
Currency theorem and axioms (im ≡ pm; im = pm) / NO / YES
im ≠ pm / NO / YES
Currency asymmetry / NO / YES
Financial asymmetry / NO / YES
Twin asymmetries / NO / YES
Control im ≡ / = pm / NO / YES
Locke’s problem / YES / NO
Gibson’s paradox / YES / NO
Keynes’ paradox / YES / NO
Liquidity trap / YES / UNDECIDED / NO
Currency demand paradox / YES / NO
Relative vs absolute prices / YES / NO
General price level / YES / NO
Indirect transmission mechanism / YES / NO
Wealth equation / Partial / Total
Phillips curve – Slope / — / —/ + / + / NO
IS/LM models and 45° curve / YES / UNDECIDED / NO
Sub-consumption theory / YES / UNDECIDED / NO
Aggregates / YES / UNDECIDED / NO
Price freedom / Blurry / Essential
Let us analyze now each one of the items
Say’s law: in our text Monetary Causality we have made ample reference to the stances of the different schools of thought. We simply reaffirm that it does not cover any scientific need since it is included in what we have called the Law of Exchange—founding pillar of the Austrian School (AS) — since all exchanges are for the benefit of all parts, derived from the same basis as human action. Ergo, no-one exchanges goods that are not economic goods (that satisfy needs based on scarcity), therefore is unscientific to propose an inverted economic causality, as implied by Say’s law, supply of goods → needs, instead of the basic economic causality need → economic good. Ie, human action, including interpersonal exchange, derives from a state of want that there is a need to overcome, and not the other way around. Keynesians reject economic causality when they reject Say, and Austrians uphold an unnecessary or redundant law, considering it is included in the law of exchange and what we have called fundamental economic causality.
It is important to point out some curious facts: the same NO of Keynesians and monetarists, with TET —bases on opposite theoretical foundations—, and the discrepancy YES-NO, between Misian Austrians and TET, with similar theoretical arguments.
Currency causality: in the text to which we have assigned this same title, we stressed how the three traditional schools of thought have violated the fundamental economic causality in Say’s law. On the contrary, TET proves it is not scientifically correct, and least still necessary, to violate that causality to develop currency theory and explain everything deriving from it (economic cycles, etc.).
Gresham’s law: in Currency Causality we have expanded on the un-necessity of this law, that arose because the three schools of thought are based on Wicksell’s virtual world —and the dichotomies derived from it— and consider that currency merits a special theory, different from all other economic goods. TET discovers that the only special economic good is economic time and its price, interest —indirect materialization, permanent positivity i > 0, and its necessary participation as a dependent factor of production present in all economic goods.
Wicksell’s “virtual” currency: also in Currency Causality, The Theory of Currency and The Theory of Interest we have extended on the unfortunate origin in Bawerkian-Wicksellian dichotomies, of all the currency and interest theory generated in the twentieth century. Thus, the whole theory of cycles of those days turned on “balancing” the virtual-currency-absolute-unreal world with the currency and real world of relative prices. TET establishes there is only one world, that is real, with relative currency and prices, pointing out that it is incorrect to develop theory pretending to reconcile a world that does not exist with another that is real.
“Special” monetary theory: also in Currency Causality we have stressed the inconsistency of the development of a special theory to explain the “phenomenon” of currency. TET has clearly shown that this is only pertinent in theories that are based on the supposition that money is a different economic good, or that it is not an economic good, that it is “virtual”, a textual and unfortunate term from Wicksell.
Emphasis on exchange: the traditional schools begin and end there developments stressing the transcendental importance represented by indirect exchange and the presence of currency, in so far as this overcame the costly state of barter. TET considers indirect exchange with the use of currency as a fact of reality —with no need for a special theory—, the same as would be true for the invention of the wheel. TET centers on the transcendent taxonomic study of the different types of currency [money – credit (regular-irregular)] and the consequences that derive from society adopting one or the other. In other words, TET is bases on the common terrain of all schools, the benefits of specialization and exchange. Ie, indirect exchange and its benefits is not subject to debate in science, and so TET builds on that common ground and analyzes the different types of exchanges (cash and credit) and the way one or the other alter exchanges (the market and its prices) and economic calculus, that all schools also uphold. Further, TET says that once the need for liquidity is established, exchanging for currency is like exchanging for bread, in the sense that they are both goods that satisfy a need, not forgetting the differences between the needs and functions each economic good covers. For a better understanding of the logical deductive causality between exchange and prices, we are including a section on the exchange → prices causality, where we will present the inverted causality that underlies traditional theoretical developments.
Monetary regression theorem: in reference to this unfortunate development by Mises there is further explanation in the Theory of Economic Relativity, Currency Theory, and Monetary Causality, and other TET writings. Though it is essential to consider the section on the Origin of currency, no matter what type, where the distance of TET —in agreement with Menger— and other schools is “very serious”.
Quantitative theory: TET rejects it, since it is already contemplated by the financial techniques in their studies of the rotation of assets-stocks, liquidity coefficients (in their different versions), asset profitability calculus, and other aspects of greater theoretical relevance presented by TET.(3) We have qualified Misian Austrians an Undecided in so far as they pronounce themselves against said theory (because it does not consider relative prices), but they use it when explaining real events, and it is even used academically by those that consider themselves to be part of that school (Hayek himself used it, and in our times so does George A Selgin,(4) and many Austrians that co-exist along with monetarists in the Mont Pelerin Society, as a second best “practical solution”).
Money ≡ Currency: TET has shown the difficulties of economic theory when developing consistent knowledge, because it considers as money everything that has the function of money. We reiterate our favorite example it is like considering the cart and the automobile to be the same because they are both means of transportation. This is the result of economic theory in the twentieth century not going beyond stressing the importance of currency in exchange, not developing the essential scientific-taxonomic aspect of any science, that in this case refers to adequately differentiating cash exchange from credit exchange, and its implications for currency, interest and the cycles —by omission validating the twin asymmetries. Concretely, until the arrival of TET, economic theory did not realize the existence of the currency theorem and its axioms.(5)
Monetary reductionism: TET stresses the inevitable reductionism of traditional schools that consider “money ≡ currency” —given the erroneous condition of “special economic good” assigned to it— turning it into the center of explanations of the economic world, as in the mercantilist stage; in both, the economy is reduced to the study, control, domination, etc., of mercantilist money and currency in the theories of the twentieth century.
Currency functions: TET stresses three functions —added to traditional ones— (6) which it considers of transcendental importance when judging the role of currency in the general economic process and in economic cycles in particular
Contractual nominativity + paying power + defining exchange
Its contents can be seen in Currency Causality, and we suggest this should be studied in depth, since it points to substantial differences when analyzing the basics that give origin to current currency-financial institutions, and its special influence on the study of cycles.
Exogenous currency: TET does not give theoretical entity to any exogenous currency, in so far as by exogenous there is the intention to refer to an economic entity that is not economic, and therefore the currency is of the same nature.(7) Ie, the study of market interventions does not require ad hoc exogenous entities.
Monetary neutrality: in so far as an economic good cannot be neutral by definition (it is a scarce good), currency cannot be so either. We qualify Keynesians and monetarists with an undecided in so far as on some occasions they are neutral and on others they are not. It is important to point out that if the Austrian School (AS)-Mises and TET agree on the non-neutrality of currency, they do so based on different theoretical grounds, which undoubtedly has implications for all theoretical developments derived from this issue: essentially everything derived from the Theory of Interest (price of time versus temporal preference) and Currency Theory, and its axioms of equality and equivalence (ic = pc e ic ≡ pc , where pc is the price of currency and ic is interest materialized in currency), form where different developments inevitably arise, even in those cases in which a superficial view of the matter can present similar aspects in the explanation (especially when Austrian theory explains cycles based on the alterations in credit markets, which cannot coincide either, because the Austrian School with Mises situates their origin in the State and the banking sector, while TET always sees its origin in the market, and many other differences).
We can close this section saying it is not appropriate to develop theory pretending to explain economic phenomena based on en the entity neutrality of an economic good, its use implies there is something wrong with the theoretical development it is part of.
Interest as the price of: currency, credit, or time: this difference speaks for itself. The Mises-AS presents two alternatives for explaining the “phenomenon” of interest: Mises’ theoretical route of the Theory of Time Preference, and Mises’ “positivist” alternative with the introduction of the “rate of interest”, deriving in interest as the price of credit. Instead, TET presents interest as the price of economic time, that when interpersonally exchanged configures credit, therefore interest is also the price of credit. Thus TET discovers that: when credit acquires the status of currency the axiom of equivalence ic ≡ pc is configured.
It is important to stress TET’s reflection on Austrian-Misian theory. Specifically, The Pure Time-Preference Theory, considering it the Austrian causal vicious circle, in so far as this develops a capital theory to prove the existence of interest, and develops an interest theory that cannot explain the existence of capital since, if the present is preferred to the future, there is no room for capital formation. On the other hand, TET, in presenting interest as the price of time not only eliminates all theoretical restrictions to the free manifestation of humane time preference (present and/or future) but also contributes important tools such as: indirect materialization (dependent variable), the currency theorem and its axioms, the category of interest as a price, the permanent positivity of interest, and the presence of economic time (and therefore interest) as a production factor in all economic goods.
We know Keynesians and monetarists consider interest to be the price of currency, which leads to assimilating them with the Austrian school when the currency is a credit, in so far as for them interest is the price of credit.
For more on this subject that is crucial tounderstand economics you can consult Carlos A. Bondone, Currency Theory, Theory of Interest, Monetary Causality, Theory of Economic Relativity, and Capitalism and Currency.
Types of credit: TET especially stresses the taxonomic aspect of economics as a science, and the theory of currency and credit specifically. As a result, when studying currency-financial institutions and their effect on economic life, TET gives primordial importance and special attention to the types of credit: regular or irregular,(8) especially when it has the status of currency —if we are referring to regular currency-credit or irregular currency-credit.
Given the huge relevance the issue of credit has for the subject of currency, we wish to reiterate that it is more precise to use the expression currency-credit than credit-currency, since what exists first is the entity economic good credit, that later acquires the status of currency, which does not deny the possibility of an economic good that appears exclusively to act as currency (Hayek’s basket of goods, PC, bitcoin, etc.). It must be observed that this does not imply Mises’ regression theorem, on the contrary, we believe Mises wanted to refer to the fact precisely that currency “first” has to be an economic good, as a necessary condition to reach the status of currency, which is what TET’s currency causality expresses (liquidity → currency), in line with the fundamental economic causality need → economic good. As a result of the deductive error of assimilating money and credit currency, Mises derived in the Theorem of Currency Regression.
Interest (+) (-)(0): TET, as opposed to traditional theories, presents interest as the price of economic time, therefore: 1) being a price it is always positive (i > 0), and 2) being present in all economic goods, that positivity is permanent, and 3) indirect materialization in other economic goods makes it a dependent variable. Ergo, TET considers theoretical entities with zero or negative interest as derivations from the dichotomic virtual Wicksellian world, of which all theories developed in the twentieth century are impregnated.(9) In other words considering the possibility of zero or negative prices can only be the result of conflicts in the theories. The variation prices can have over time is a different matter and it’s analysis cannot overlook the fact that a price is unique and unrepeatable in terms of space and time, ie, comparing prices is an excellent tool for economic calculus which is invaluable, but that is all (for more see exchange → prices causality).