Why Omniscience is a Prerequisite for Successful Central Banking

Statements such as ‘The Federal Reserve should have done such and such’ or ‘The Bank of Japan shouldn’t have done this and that’ are often uttered by market analysts and commentators. Although these analysts and commentators are often well-intentioned and healthily skeptical, their statements contain a fallacious premise (in my mind): that central banks could have succeeded.

     

    Cartoon with Bernanke and an Angel - About Omniscience & Central Banking

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    Here, I attack the notion that central bankers are capable of satisfactorily producing money. I’ll argue as follows:

     

    • Money is a good like any other.
    • Attempts to centrally plan any good must fail (in the absence of an omniscient central planner).

    Hence;

     

    • Attempts to centrally plan money must also fail (in the absence of an omniscient central banker).

     

    Taking Money off its Pedestal:

     

    Money – it is said – is ‘special’. This ‘specialness’ is deemed to imply that it must be produced by government and/or government-backed institutions. As is evidenced by the harsh punishments inflicted upon Bernard von NotHaus (the former ‘liberty dollar’ producer), anything else is just unthinkable.

     

    However, money is ‘just’ a “good”. Admittedly, it is particularly and uniquely valued for its widespread marketability, but so are McDonald’s hamburgers valued for their unique and particular McDonald’s-ness. The key point is that money belongs to the class of “goods”; that is, it is valued (and hence “good” for us). In each transaction in an economy, the money and the good exchanged stand equally against one another: the person who buys – say – apples is as much ‘selling money’ as he/she is ‘buying apples’. Likewise, the person who sells apples is as much ‘buying money’ as he/she is ‘selling apples’. Moreover, to emphasize that money is a good, we should note that money must originate from a commodity (quoting Hans Hermann Hoppe in How is Fiat Money Possible?-or, The Devolution of Money and Credit):

     

    Money must emerge as a commodity money because something can be demanded as a medium of exchange only if it has pre-existing bater demand (indeed, it must have been a highly marketable bater commodity), …

     

    With this understood, it should be clear that the ‘problem’ of scarcity applies to money in the same way that it applies to any other good. What proportion of our scarce resources should be put into the production of money?

     

    The Allocation of Scarce Resources without  a Functioning Market:

     

    The epic problem of the central planner is that he cannot know how much to produce. He cannot rationally answer the following questions; what quantity of a given good is the ‘right’ quantity? What quantity is productive and not wasteful? What level of production yields something better than what was used to make it? A character from Henry Hazlitt’s Time Will Run Back went through these dilemmas:

     

    If I’m shooting at a target, and my shot falls approximately a foot below the bull’s eye, I try to raise my next shot by a foot; if my shots are going too far to the left, I aim more to the right. If a chef broils a steak and finds it overdone, he leaves the next steak over the fire a shorter time. And so on. But what standard have you got for error in the problem we are trying to solve? How do you know that the production of some particular item is costing more than it is worth? How do you know whether or not you are adopting the most economical method of making that item or any other item?

     

    When applied to money, these questions start to sound rather familiar; what level of money supply growth is the ‘right’ one (if any)? What interest rate is the ‘right’ one? What interest rate is productive and not harmful? What level of money production yields something better than what it took to make that money? How can we know?

     

    The fact is that anyone claiming to have the ‘right’ answers to the questions without market information must claim to have perfect knowledge about the preferences of all economic actors involved. But any man – to be sure – can only perceive what he can perceive. In this way, his knowledge of things (inlcuding other economic actors) is both subject to the things that he is perceiving and his apparatus of perception. This mortal limitation implies that no man can have such knowledge about even one other economic actor (let alone all economic actors). Hence, the only entity that can claim to centrally plan any good (including money) must have some kind of knowledge of things that transcends human perception – central planners would have to be omniscient to be successful.

     

    Conclusion:

     

    Money is a good that is valued for its superlative marketability. Just as with any other good, a market is required for rational production. Any attempts to centrally plan money must fail as central bankers do not have the means by which to determine how much should be produced.

     

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    Posted Apr 28, 2011
    • Joe

      Correct premise, faulty analysis. A central banks only means of new money creation is inducing borrowers to borrow new loans from the banking system. New debts create new money. Central banks can do this only lowering interest rates. In an overleveraged economy where borrowers are deleveraging (as now), there is no new loan demand regardless of the level of interest rates and the money supply will contract let alone not grow.

      However, the U.S. Treasury can also create new money by simply spending it into the economy by purchasing goods and services. The larger the defict, the more new money in the economy. The Treasury can also destroy money by taxing it out of the economy or by spending less with a surplus.

      This ain’t rocket science and doesn’t require omniscience. It’s just math. When the Fed is rendered powerless and money supply contracts from private sector loan liquidation, the public sector, the government, must increase it’s spending in the economy by the exact amount of loan liquidation or we will have a recession. End of story. There is no possible way that the act of decreasing federal spending before the deleveraging process has run it’s course can not result in further economic contraction. Nor is there any way that further reductions in federal spending and deficits can stimulate loan demand in an already ZIRP environment.

      I hope this helps simplify what is generally otherwise held to be complex with a lot of analytical smoke and mirrors.

      btw – Don’t make the mistake of thinking that “funding” the federal deficit by selling bonds takes money out of the economy. Bond sales do no such thing. Treasury bond sales only drain idle excess reserves out of the banking system (not the economy)in order to allow the Fed to hit its target interest rates. The government can “fund” or “create” as big of a deficit as it wants to (eg. WWII deficit levels) without inflation by following this method.

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

        Thanks for your thoughts Joe.

        Correct premise, faulty analysis. A central banks only means of new money creation is inducing borrowers to borrow new loans from the banking system. New debts create new money. Central banks can do this only lowering interest rates. In an overleveraged economy where borrowers are deleveraging (as now), there is no new loan demand regardless of the level of interest rates and the money supply will contract let alone not grow.

        I agree that we’re in a deleveraging environment (as you may know), and I agree that loan demand is weak/non-existent and that hence there are contractionary forces for ‘IOU money’ (i.e. demand deposits at depository institutions). My contentions in the article aren’t antagonistic to these tendencies.

        However, the U.S. Treasury can also create new money by simply spending it into the economy by purchasing goods and services. The larger the defict, the more new money in the economy. The Treasury can also destroy money by taxing it out of the economy or by spending less with a surplus.
        This ain’t rocket science and doesn’t require omniscience. It’s just math. When the Fed is rendered powerless and money supply contracts from private sector loan liquidation, the public sector, the government, must increase it’s spending in the economy by the exact amount of loan liquidation or we will have a recession. End of story. There is no possible way that the act of decreasing federal spending before the deleveraging process has run it’s course can not result in further economic contraction. Nor is there any way that further reductions in federal spending and deficits can stimulate loan demand in an already ZIRP environment.

        In my mind, the problem lies here. I disagree with the notion that the ‘right’ money supply is that money supply that averts a recession. As I say in the article above, money is originates from a good and is – itself – a “good”. In this world of scarcity (which is inescapable by the nature of human perception), the question of ‘what money supply is the right one?’ is pertinent. This – I contend – lies in the individual perceptions of the mass of market participants and not in any individual’s perceptions of other individuals’ perceptions. So whenever we say, ‘the right money supply is that which averts a recession’, or ‘that which gives an annual price rise of 2%’ or whatever else. We say something that is not universally valid (i.e. true in the nature of rational beings), and yet we are saying something that denies something true about the nature of rational beings (private property rights).

        So, as with every other good, I say leave it to the market. That is, leave it naturally to us.

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