Unemployment, the “Money Illusion” & Herding

With the unemployment rate at historically high levels, many commentators have taken the time to theorize upon it. The Austrian School have – with justification – blamed the issue on the folly of central planning in the monetary sphere. As far as it goes, I have no bone to pick with this notion. However, we should not be blinded by our own circumstances and should consider that there is certainly more behind this issue. The protagonists of these theories occasionally skip the simple stuff: the influences of the “money illusion” and herding.


The Employment Contract & Unemployment:


In order for an employment contract to take shape, an employer and an employee have to find a mutually beneficial deal. Such ‘deal-finding’ is enabled by inverse preferences; the employee thinks he’s getting a good deal by selling his services for money (at the agreed price) and the employer thinks he’s getting a good deal by buying those services with money (at the agreed price).


The essence of unemployment is that employers and employees cannot find deals with one another. That is, people’s preferences aren’t aligned such that they can enter employment contracts. The people who want to be employed can’t find employers that will pay them ‘enough’, and the people who want to employ can’t find employees that will take what they want to give. In short, employers and employees can’t find people to take the other sides of their proposed contracts.


Commentators focus on the Employer-side:


Whenever I read articles about unemployment, I find myself both shrugging and nodding; as if to say ‘yes indeed, but that’s not all’. I find that commentators focus on the ‘employer-side’ issues and deem ‘employee-side’ issues to be an axiomatic given. Of course, they aren’t a given.


It takes two to tango:


The essence of unemployment is that people can’t find deals in the sphere of jobs. So, we can’t exclusively think about intervention; we also have to think about – in a rudimentary sense – why employers bids for employees aren’t getting filled. Why is it that potential employees are unwilling to take the offers made by employers? And likewise, why is it that potential employers are unwilling to take offers made by employees? In some sense, employees must deem the offered rates to be ‘too low’ and employers must deem the demanded wages to be ‘too high’. This has to be the case.


There are many potential reasons why preferences are aligned in this way. Indeed, we can never know why; each man’s mind is an island. However, my guess is that a significant part of these ‘misaligned’ preferences can be attributed to the “money illusion” and herding.


The “Money Illusion”:


Do you consider it preposterous that a well-educated engineer formerly on $40/hour should accept $10/hour? My guess is that, at the very least, he does. But what is the essence and root of his rejection of the new proposed wage? I say that it is based on his perception of dollars; he thinks that it is meaningful and intelligible to compare his former wages with today’s proposed wages. He falls prey to the trap of the “money illusion”. The dollar isn’t an abstract unit of account; it’s a thing – albeit a convoluted and esoteric thing. Not only does its value change (as with everything else), but it is also constantly changing in composition (thanks to our overlords at the Fed). That is, the dollar becomes ‘good for’ quantitatively and qualitatively different things every day.


As Irving Fisher noted in his quaint book The Money Illusion:


… the “Money Illusion”; that is, the failure to perceive that the dollar, or any other unit of money, expands or shrinks in value. We simply take it for granted that “a dollar is a dollar” – that “a franc is a franc,” that all money is stable, just as centuries ago, before Copernicus, people took it for granted that this earth was stationary, that there was really such a fact as a sunrise or a sunset. We know now that sunrise and sunset are illusions produced by the rotation of the earth around its axis, and yet we still speak of, and even think of, the sun as rising and setting!


Herding & Inflation Worries:


Let’s suppose that our engineer is aware of the “money illusion”. Suppose that he takes the new job at $10/hour. What other obstructions lie in the road ahead? If the “money illusion” is prevalent in other minds, then this can be a significant obstruction. You can imagine the whispers of his adversaries and friends alike; “Did you hear about X? He used to work as an engineer for $40/hour, and now he’s working for $10/hour!”. Can you see how this might be a difficult thing to deal with? To live with the (unjustified) contempt of almost everyone you meet is a difficult prospect for the most independent of souls! The herd – although perhaps wise in some endeavours – is clueless when it comes to modern financial transactions in fiat currencies.


What’s more is that – for those not subject to the “money illusion” – inflation worries have risen to fantastic proportions. Just a year or two ago, the notion that the Fed ‘prints’ money was derided and scorned. Now it is embraced and emphatically feared. The implications are peculiar: a great number of people who readily acknowledge that the future is unknowable, have ferocious conviction in the prospect of an inflationary future. It’s basically ‘guaranteed’, right? If this is the main topic of group-thought, do you see how people might be very reluctant to take a (nominal) haircut on their wages? The class of employers are being squeezed for all they’re worth, and a subset of the class of employees are intent on not getting ‘suckered’ into the inflation trap.


Explanations that appeal to the people:


I doubt that the above would be palatable for most people: in particular, for the unemployed. You don’t want to hear that you’re going to have to take a 50% (nominal) haircut on your wages, especially if you believe in an inflationary future.


Is it any wonder that people get bogged down in employer-side explanations of the high unemployment rate? Indeed, with the rigour, bravery and conviction of the Austrian School, is it any wonder that it should increase in popularity when the focus of its endeavours is to expose the folly of interventionism?


Don’t get me wrong, I admire the great thinkers of the Austrian School, but I have misgivings with their rise to popularity. I think that some of their new followers will disappear as soon as the intellectual convictions of the Austrian School contradict their personal circumstances and mood. As some examples of the ficklenesss of the new Austrian/Libertarian crowd, consider the following:


  • A CNBC presenter recently claimed that his viewers are ‘mainly Austrian’.
  • In the UK, the UKIP party preposterously calls itself ‘libertarian’.
  • When the mises.org blog posted an insightful view on the history of Islam, it was viciously opposed.




I admire the intellectual rigour of anti-interventionist schools of thought; however, we shouldn’t get carried away and ignore the fact that it takes two to tango. In dealing with unemployment, both the ‘employer-side’ and ‘employee-side’ should be (frankly) considered.


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Posted Mar 22, 2011
  • Helix

    Inflation is coming but it takes more time than most expect. At first its a illusion of growth and we are getting closer to this stage now. Then it will hit us and that is when the Gods at the FED will start raising there rates and at that time billions will flow back in to the US and feed even more inflation. = Stagflation.

    Most economic theories are only rationalization of economic interventions. We don’t need to rationalize physics do we? If we had a primitive bartering economy there could not be inflation. I don’t think the Amish suffers from inflation. Obviously they have a very small and static kind of economy but even if they where to double there production absolutely nothing would happen to destabilize there economies. Modern money is nothing but the manipulation of the medium of exchange that in reality should be nothing more or less than a constant, non depreciating and honest claim on good and services. (and it does not need to be Gold or any metal to accomplish this.

    We should be investing with confidence in the long term “real” growth of the economy instead of protecting our earnings and wealth against the Treasury and Central Banks devastation and market bubbles.

    • http://greshams-law.com Aftab Singh

      You’re right Helix, it’s just a colossal misdirection of time and resources. Those who might have been producing and innovating spend their time worrying about where the S&P 500 is going to trade in 6 months..

      • Helix

        But I do agree with you its the way it is and its useless to complain as we are here to make money. When you decide to swim across a lake if there is a storm coming half way in, you need not analyses the weather system, you need to get to the other side and fast.