Regulating towards depression

There have been many books attempting to find and explain the causes of the ongoing financial crisis.  Authors have approached the issue from all sorts of ideological perspectives and with different sets of evidence.  Most of these works are lacking, incomplete, or even flat-out wrong.  Many of them do not even care for the facts, instead using vague generalizations to justify the application of broad economic theories.  There has not, until recently, really been a meticulous analysis of the mechanics of the causes of the Great Recession, despite the enormous interest displayed by the economics profession in the subject.

This lacuna has been filled by Jeffrey Friedman, editor of Critical Review, and Wladimir Kraus, in their recently published book: Engineering the Financial Crisis.   The authors make the purpose of their study evident from the very beginning.  They shed themselves of any ideological priors which may have otherwise impaired their analysis, even going as far as to disprove a number of general theories from either side of the spectrum (insufficient regulation versus insufficient economic freedom), and task themselves simply with accumulating, analyzing, and interpreting the evidence.  The data they look at has to do with the regulations which governed the financial institutions that presided over the network of financial instruments which suddenly lost the bulk of their value.  The question they ask is a simple one: based on the facts, was the recession caused by under-regulation or was it something in the regulation itself which may have influenced the ways banks invested?

Friedman and Kraus give reason to believe that it was the latter — perverse regulations — which gave way to the great contraction which took place between 2007 and 2009.  Looking through the relevant legislature which dictates the laws governing the banking industry, the authors find that it was this regulatory web which led banks to invest in the specific financial assets that would soon after be deemed nearly worthless.

Friedman and Kraus emphasize the importance of the fact that the banking industry had no idea — what they call “radical ignorance” — about just what kind of quagmire they were investing themselves into.  They use evidence to illustrate the fact that, predominately speaking, the bankers, regulators, politicians, and other major actors in this crisis had absolutely no idea of the relevant potential for a recession to occur, let alone that the highly rated assets they invested into would soon become relatively valueless.

We can see now the broad thesis of Engineering the Financial Crisis.  Bankers did not buy large amounts of soon-to-be “toxics assets” because the risk had been externalized to the taxpayer. [1] Neither is their any evidence suggesting that bankers purposefully ignored high risk in favor of pursuing high profits.  The majority of assets purchased were actually AAA rated, and because of this the risk-load they carried, as perceived at the time of purchase, was relatively low.  What manipulated the relevant price signals which funneled investment into the housing market were regulations which rewarded these type of investments. To a lesser extent, the authors also point at government programmes which pushed for house ownership and the relatively low rates of interest on new loans which made borrowing seemingly more affordable.

Leading up to the crisis, bankers were generally very risk sensitive, preferring assets with lower revenue returns.  Roughly 93 percent of mortgage bonds held by U.S. Commercial banks were AAA-rated mortgage backed securities (both private label [PLMBS] and agency rated [MBS]), and almost another 7 percent were AAA-rated collectivized debt obligations (CDO). [2] Missing from this collection of assets were any mortgage bonds rated less than AAA, which were usually the bonds which the highest rate of return.

Most commercial banks in the United States were also above their legal capital reserve minimum on the eve of the financial crisis — the twenty largest banks held capital levels averaging 11.7 percent, where the legal minimum was 10 percent of a bank’s total assets (as dictated by the Federal law, whereas the Basel I accords had set it at 8 percent).  More specifically, if one only accounts for “Tier 1” capital [3] banks retained a capital cushion of 50 percent, even while federal law required a minimum of 5%.  In other words, most banks opted to retain a substantial capital cushion, where one would expect a bank interested in maximizing profit (while ignoring risk) to push the boundaries of its legal requirements. [4]

The issue, then, was not about bankers with low risk aversion, seeking high profits by investing mostly in high-risk assets.  The evidence suggests quite the contrary.  U.S. commercial banks invested in what were perceived as low-risk, low-return assets, and on top of this held higher than required capital cushions.  Also going out the window is the “too big to fail” theory, or any other case that argues that it was risk externalization which created an incentive for an over-concentration of investment into the mortgage market.  Simply put, there was a high aversion to risk during the years leading up to the crisis.

Friedman’s and Kraus’ explanation of what caused the crisis can be divided into two parts: what caused the over-concentration of investment into mortgage-backed securities and why these securities, which by 2008 had lost the majority of their value, had been rated so highly by the major rating agencies.  The strength of their book is found in its accounting of the first — what led to the pattern of investment that characterized U.S. commercial bank assets prior to the recession.

Because different types of investments generally have different degrees of risk, a capital requirement minimum that encompasses all assets is illogical.  Rather, it makes more sense to create different capital reserve requirements for different sorts of investments, based on the general perceived riskiness of the different types.  The Basel I accord was an attempt to correct the issues of a homogenous treatment of assets by creating different categories and attaching a capital reserve minimum to each category.  Higher risk assets, therefore, were categorized into higher “risk buckets” and required a greater capital cushion.  In other words, the greater the risk the asset carried, the more it cost the banks to protect against, by reducing the amount of capital available to invest.

The issue, as explained by Friedman and Kraus, is that these regulations led to “regulatory arbitrage”.  For example, a bank could invest into mortgage bonds with a risk-weight of 50 percent, then re-sell these bonds to a government sponsored enterprise (such as Freddie Mac and Fannie Mae), and buy them back as an agency bond.  These agency bonds were risk-weighted at 20 percent, effectively reducing the capital cushion necessary to back the asset, even though the composition of the asset remained exactly the same.  The Basel regulations made it more expensive to issue business loans than home loans, creating a financial incentive to issue more home loans.  Basel I created incentives for banks to make certain types of loans and then securitize them.

A further boon to securitization came with the adoption of the Recourse Rule, which borrowed the Basel II accord’s method of rating privately issued securitized assets by risk.  This system caused banks to increase investment in AAA-rated securitized mortgage bonds, especially since the risk-weight of unsecuritized mortgages remained at 50 percent (as dictated by Basel I).  It remained cheaper to invest in mortgages, rather than other types of loans to consumers and businessmen, and then banks could further increase profitability by securitizing these mortgages and releasing part of their capital reserves for further investments.  This explains the concentration of investment in mortgage backed securities.

We see a pattern between 2001 and 2007 of an increase in housing loans and investment into mortgage backed securities.  We know that at the time these types of investments being made were being pooled into buckets which were considered generally less risky than other forms of investment.  It was not an issue, therefore, of carrying on more risk.  In fact, this pattern of investment was created out of the fact that the regulations incentivized purchase of less risky assets.  The problem which led to the financial collapse, therefore, deals exclusively with the fact that these assets carried more risk than was originally perceived by the regulators (and banks).  In fact, the collapse of the subprime mortgage market came as a total surprise, both for the bankers and the regulators.

It was not just the architecture of the impending financial collapse that the regulatory web was responsible for, but also the magnification of the disaster.  Thanks to the capital reserve minima, many banks faced insolvency even though the circumstances did not really call for it.  In order to remain legally solvent, U.S. banks are forced to maintain a certain capital reserve minimum.  As the crisis unfolded, bonds which had been previously rated at AAA were suddenly downgraded, raising the necessary capital reserve minima for each risk-bucket.  In other words, as ratings fell for different types of bonds, banks were suddenly forced to raise new capital to cover their loss.

Furthermore, regulations forced banks to mark-to-market their assets to reveal their “true value”.  This process was not done on an individual basis; rather, different bonds were lumped together and them marked-to-market as a group.  So, even individual bonds which may have not actually lost  value were readjusted on a bank’s balance sheet as assets that were suddenly worth less than had been perceived prior to the crisis.  It was on the basis of these new market values that a bank’s solvency was judged.  The issue is that by late 2009 many of these same bonds had recuperated much of their value, and so a bank that had been legally insolvent in early 2008 may not have been two years later.  In other words, many banks were forced into insolvency that could have survived the crisis, and other banks had to radically contract outstanding liabilities in order to remain solvent.

The consequence of these regulatory restrictions was a giant credit contraction — much larger than was actually necessary.  And, of course, the monetary contraction only worsened the situation, as it reduced the financial viability of the various investments that depended on this credit.

Friedman and Kraus blame the inadequate rating of mortgage bonds on the cartelization of the major rating agencies — Moody’s, Standard & Poor’s (S&P), and Fitch.  Basel II and the Recourse Rule had effectively tied their capital reserve requirements to the ratings provided by these three agencies.  It was these three rating agencies that had been classified as Nationally Recognized Statistical Rating Organizations by the Securities and Exchange Commission (SEC) in 1975, and the various regulations that relied on risk ratings depended exclusively on this cartel.  None of the three “nationally recognized” rating agencies, furthermore, had accounted for the possibility of a nationwide hosing crisis leading up to 2008.

There were private rating agencies, though, that had recognized the potential for crisis.  According to Friedman and Kraus one such company was First Pacific Advisors, which sold its $1.85 billion investment in mortgage-backed bonds in late 2005.

Friedman’s and Kraus’ analysis hinges on the notion that what was ultimately at fault were these rating agencies.  Had they been more accurate in their risk assessments then banks would not have malinvested in so many mortgage-backed bonds.  But, why had the banks relied exclusively on the risk-assessment provided by the three “nationally recognized” agencies?  Were these banks not aware of the risk assessments being made by private investment companies?

Perhaps the authors put too much weight on the notion that it was this cartelization of the rating agencies which made possible the crisis, and that had there been more competition in this industry the recession may have been less destructive than it turned out to be.  But, Friedman and Kraus do not make clear exactly how many private agencies had foreseen the crisis.  Few investors sold off their mortgage-backed bonds in anticipation of a market crash.  Indeed, the majority of investors were still fairly confident in the strength of the housing market.

Here is where the explanation of the crisis becomes more detached from the data.  Friedman and Kraus leave room for further interpretation, since their explanation for why the different bonds were assessed as they were comes off as inadequate (or, at least, incomplete).  Understandably, they are looking to separate themselves from ideology — even though the book’s conclusions are extremely pro-market — and thus avoid applying far-reaching theories to the evidence they were able to collect

However, that there is still room for further interpretation is not necessarily a bad thing.  As far as their analysis on the impact of regulations on the housing boom and the consequent financial crisis goes, it is difficult to refute.  That there is still room for the application of theory means that their empirical findings can easily be assimilated into grander explanations of the financial crisis.

For the task it sets out to accomplish, Engineering the Financial Crisis is undoubtedly one of the best books written yet on the causes of the Great Recession.  Jeffrey Friedman and Wladimir Kraus painstakingly dig through the data to provide a solid picture of why there was such an overconcentration of investment in the mortgage market.  The evidence clearly shows that it was the web of regulation on the banking industry that shaped the structure of banking investment by favoring certain investments over others.  The entire system collapsed when it turned out that these regulations had depended on agency assessments that had totally miscalculated the risk these favoured assets carried.  Thus, banks had loaded themselves up with mortgage backed bonds, completely unaware of the fact that these bonds would soon be relatively valueless.  It was not the market which caused the crisis, rather the distortions to the market that were created by government intervention.

[1] That banks did not buy mortgage-backed securities and other similar assets because the bankers knew that there was no risk for them is a very specific claim, and it does not include many banking practices which are undertaken because of risk externalization (such as the extent of fiduciary expansion, which in our present banking system is a product of its cartelization under the Federal Reserve System).

[2] Friedman and Kraus 2011, p. 42 (table 1.3).

[3] Basel I divides bank capital by the type of asset, Type I being the safest pool.  Type I is composed of “funds received from sales of common equity shares and from retained earnings.” Ibid., p. 40.

[4] A capital reserve basically allows banks to take losses, since it gives it a cushion of assets it can capitalize on to make up for net losses (before liabilities exceed assets).


Prices and the demand for money

Banking theory remains one of the most heatedly debated areas of economics within Austrian circles, with two camps sitting opposite each other: full reservists and free bankers.  The naming of the two groups may prove a bit misleading, since both sides support a free market in banking.  The difference is that full reservists believe that either fractional reserve banking should be considered a form of fraud or that the perceived inherent instability of fiduciary expansion will force banks to maintain full reserves against their clients’ deposits.  The term free banker usually refers to those who believe that a form of fractional reserve banking would be prevalent on the free market.

The case for free banking has been best laid out in George Selgin’s The Theory of Free Banking.[1] It is a microeconomic theory of banking which suggests that fractional reserves will arise out of two different factors,

  1. Over time, “inside money” — banknotes (money substitute) — will replace “outside money” — the original commodity money — as the predominate form of currency in circulation.  As the demand for outside money falls and the demand for inside money rises, banks will be given the opportunity to shed unnecessary reserves of commodity money.  In other words, the less bank clients demand outside money, the less outside money a bank actually has to hold.
  2. A rise in the demand to hold inside money will lead to a reduction in the volume of banknotes in circulation, in turn leading to a reduction of the volume of banknotes returning to issuing banks.  This gives the issuing banks an opportunity to issue more fiduciary media.  Inversely, when the demand for money falls, banks must reduce the quantity of banknotes issued (by, for example, having a loan repaid and not reissuing that money substitute).

Free bankers have been quick to tout a number of supposed macroeconomic advantages of Selgin’s model of fractional reserve banking.  One is greater economic growth, since free bankers suppose that a rise in the demand for money should be considered the same thing as an increase in real savings.  Thus, within this framework, fractional reserve banking capitalizes on a greater amount of savings than would a full reserve banking system.

Another supposed advantage is that of monetary equilibrium.  An increase in the demand for money, without an equal increase in the supply of money, will cause a general fall in prices.  This deflation will lead to a reduction in productivity, as producers suffer from a mismatch between input and output prices.  As Leland Yeager writes, “the rot can snowball”, as an increase in uncertainty leads to a greater increase in the demand for money.  This can all be avoided if the supply of money rises in accordance with the demand for money (thus, why free-bankers and quasi-monetarists generally agree with a central bank policy which commits to some form of income targeting).[2]

Monetary (dis)equilibrium theory is not new, nor does it originate with the free bankers.  The concept finds its roots in the work of David Hume[3] and was later developed in the United States during the first half of the 20th Century.[4] The theory saw a more recent revival with the work of Leland Yeager, Axel Leijonhufvud, and Robert Clower.[5] The integration of monetary disequilibrium theory with the microeconomic theory of free banking is an attempt at harmonizing the two bodies of theory.[6] If a free banking system can meet the demand for money, then a central bank is unnecessary to maintain monetary stability.

The integration of the macro theory of monetary disequilibrium into the micro theory of free banking, however, should be considered more of a blemish than an accomplishment.  It has unnecessarily drawn attention away from the merits of fractional reserve banking and instead muddled the free bankers’ case.  Neither is it an accurate or useful macroeconomic theory of industrial misbalances or fluctuations.[7]

The Nature of Price Fluctuations

The argument that deflation resulting from an increase in the demand for money can lead to a harmful reduction in industrial productivity is based on the concept of sticky prices.  If all prices do not immediately adjust to changes in the demand for money then a mismatch between the prices of output and inputs goods may cause a dramatic reduction in profitability.  This fall in profitability may, in turn, lead to the bankruptcy of relevant industries, potentially spiraling into a general industrial fluctuation.  Since price stickiness is assumed to be an existing factor, monetary equilibrium is necessary to avoid necessitating a readjustment of individual prices.

Since price inflexibility plays such a central role in monetary disequilibrium, it is worth exploring the nature of this inflexibility — why are prices sticky?  The more popular explanation blames stickiness on an entrepreneurial unwillingness to adjust prices.  Those who are taking the hit rather suffer from a lower income later than now.[8] Wage stickiness is also oftentimes blamed on the existence of long-term contracts, which prohibit downward wage adjustments.[9]

Austrians can supply an alternative, or at least complimentary, explanation for price stickiness.[10] If equilibrium is explained as the flawless convergence of every single action during a specific moment in time, Austrians recognize that an economy shrouded in uncertainty is never in equilibrium.  Prices are set by businessmen looking to maximize profits by best estimating consumer demand.  As such, individual prices are likely to move around, as consumer demand and entrepreneurial expectations change.  This type of “inflexibility” is not only present during downward adjustments, but also during upward adjustments.  It is “stickiness” inherent in a money-based market process beset by uncertainty.

It is true that government interventionism oftentimes makes prices more inflexible than they would be otherwise.  Examples of this are wage floors (minimum wage), labor laws, and other legislation which makes redrawing labor contracts much more difficult.  These types of labor laws handicap the employer’s ability to adjust his employees’ wages in the face of falling profit margins.  Wages are not the only prices which suffer from government-induced inflexibility.  It is not uncommon for government to fix the prices of goods and services on the market; the most well-known case is possibly the price fixing scheme which caused the 1973–74 oil crisis.  There is a bevy of policies which can be enacted by government as a means of congesting the pricing process.

But, let us assume away government and instead focus on the type of price rigidity which exists on the market.  That is, the flexibility of prices and the proximity of the actual price to the theoretical market clearing price is dependent on the entrepreneur.  As long as we are dealing with a world of uncertainty and imperfect information, the pricing process too will be imperfect.

Price rigidity is not an issue only during monetary disequilibrium, however.  In our dynamic market, where consumer preferences are constantly changing and re-arranging themselves, prices will have to fluctuate in accordance with these changes.  Consumers may reduce demand for one product and raise demand for another, and these industries will have to change their prices accordingly: some prices will fall and others will rise.  The ability for entrepreneurs to survive these price fluctuations depends on their ability to estimate consumer preferences for their products.  It is all part of the coordination process which characterizes the market.

The point is that if price rigidity is “almost inherent in the very concept of money”,[11] then why are price fluctuations potentially harmful in one case but not in the other?  That is, why do entrepreneurs who face a reduction in demand originating from a change in preferences not suffer from the same consequences as those who face a reduction in demand resulting from an increase in the demand for money?

Price Discoordination and Entrepreneurship

In an effort to illustrate the problems of an excess demand for money, some have likened the problem to an oversupply of fiduciary media.  The problem of an oversupply of money in the loanable funds market is that it leads to a reduction in the rate of interest without a corresponding increase in real savings.  This leads to changes in the prices between goods of different orders, which send profit signals to entrepreneurs.  The structure of production becomes more capital intensive, but without the necessary increase in the quantity of capital goods.  This is the quintessential Austrian example of discoordination.

In a sense, an excess demand for money is the opposite problem.  There is too little money circulating in the economy, leading to a general glut.[12] Austrian monetary disequilibrium theorists have tried to frame it within the same context of discoordination.  An increase in the demand for money leads to a withdrawal of that amount of money from circulation, forcing a downward adjustment of prices.

But there is an important difference between the two.  In the first case, the oversupply of fiduciary media is largely exogenous to the individual money holders.  In other words, the increase in the supply of money is a result of central policy (either by part of the central bank or of government).  Theoretically, an oversupply of fiduciary media could also be caused by a bank in a completely free industry but it would still be artificial in the sense that it does not reflect any particular preference of the consumer.  Instead, it represents a miscalculation by part of the central banker, bureaucrat, or bank manager.  In fact, this is the reason behind the intertemporal discoordination — the changing profit signals do not reflect an underlying change in the “real” economy.

This is not the issue when regarding an excess demand for money.  Here, consumers are purposefully holding on to money, preferring to increase their cash balances instead of making immediate purchases.  The decision to hold money represents a preference.  Thus, the decision to reduce effective demand also represents a preference.  The fall in prices which may result from an increase in the demand for money all represent changes in preferences.  Entrepreneurs will have to foresee or respond to these changes just like they do to any other.[13] That some businessmen may miscalculate changes in preference is one thing, but there can be no accusation of price-induced discoordination.

The comparison between an insufficient supply of money and an oversupply of fiduciary media would only be valid if the reduction in the money supply was the product of central policy, or a credit contraction by part of the banking system which did not reflect a change in consumer preferences.  But, in monetary disequilibrium theory this is not the case.

None of this, however, says anything about the consequences of deflation on industrial productivity.  Will a rise in demand for money lead falling profit margins, in turn causing bankruptcies and a general period of economic decline?

Whether or not an industry survives a change in demands depends on the accuracy of entrepreneurial foresight.  If an entrepreneur expects a fall in demand for the relevant product, then investment into the production of that product will fall.  A fall in investment for this product will lead to a fall in demand for the capital goods necessary to produce it, and of all the capital goods which make up the production processes of this particular industry.  This will cause a decline in the prices of the relevant capital goods, meaning that a fall in the price of the consumer good usually follows a fall in the price of the precedent capital goods.[14] Thus, entrepreneurs who correctly predict changes in preference will be able to avoid the worst part of a fall in demand.

Even if a rise in the demand for money does not lead to the catastrophic consequences envisioned by some monetary disequilibrium theorists, can an injection of fiduciary media make possible the complete avoidance of these price adjustments?  This is, after all, the idea behind monetary growth in response to an increase in demand for money.  Theoretically, maintaining monetary equilibrium will lead to a stabilization of the price level.

This view, however, is the result of an overly aggregated analysis of prices.  It ignores the microeconomic price movements which will occur with or without further monetary injections.  Money is a medium of exchange, and as a result it targets specific goods.  An increase in the demand for money will withdraw currency from this bidding process of the present, reducing the prices of the goods which it would have otherwise been bid against.  Newly injected fiduciary media, maintaining monetary equilibrium, is being granted to completely different individuals (through the loanable funds market).  This means that the businesses originally affected by an increase in the demand for money will still suffer from falling prices, while other businesses may see a rise in the price of their goods.  It is only in a superfluous sense that there is “price stability”, because individual prices are still undergoing the changes they would have otherwise gone.

So, even if the price movements caused by changes in the demand for money were disruptive — and we have established that they are not — the fact remains that monetary injections in response to these changes in demand are insufficient for the maintenance of price stability.

Implications for Free Banking

To a very limited degree, free banking theory does rely on some aspects of monetary disequilibrium.  The ability to extend fiduciary media depends on the volume of returning liabilities; a rise in the demand for money will give banks the opportunity to increase the supply of banknotes.  However, the complete integration of monetary disequilibrium theory does not represent theoretical advancement — if anything, it has confused the free bankers’ position and unnecessarily contributed to the ongoing theoretical debate between full reservists (many of which reject the supposed macroeconomic benefits of free banking) and free bankers.

We know that an increase in the demand for money will not lead to industrial fluctuations, nor does it produce any type of price discoordination.  Like any other movement in demand, it reflects the preferences of the consumers which drive the economy.  We also know that monetary injections cannot achieve price stability in any relevant sense.  Thus, the relevancy of the macroeconomic theory of monetary disequilibrium is brought into question.  Free banking theory would be better off without it.

This suggests, though, that a rejection of monetary disequilibrium is not the same as a rejection of fractional reserve banking.  It could be the case that a free banking industry capitalizes on an increase in savings much more efficiently than a full reserve banking system.  Or, it could be that the macroeconomic benefits of fractional reserve banking are completely different from those already theorized, or even that there are no macroeconomic benefits at all — it may purely be a microeconomic theory of the banking firm and industry.  These aspects of free banking are still up for debate.

[1] George A. Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue (Totowa, New Jersey: Rowman & Littlefield, 1988).  Also see George A. Selgin, Bank Deregulation and Monetary Order (Oxon, United Kingdom: Routledge, 1996); Larry J. Sechrest, Free Banking: Theory, History, and a Laissez-Faire Model (Auburn, Alabama: Ludwig von Mises Institute, 2008); Lawrence H. White, Competition and Currency (New York City: New York University Press, 1989).

[2] Leland B. Yeager, The Fluttering Veil: Essays on Monetary Disequilibrium (Indianapolis, Indiana: Liberty Fund, 1997), pp. 218–219.

[3] Ibid., p. 218.

[4] Clark Warburton, “Monetary Disequilibrium Theory in the First Half of the Twentieth Century,” History of Political Economy 13, 2 (1981); Clark Warburton, “The Monetary Disequilibrium Hypothesis,” American Journal of Economics and Sociology 10, 1 (1950).

[5] Peter Howitt (ed.), et. al., Money, Markets and Method: Essays in Honour of Robert W. Clower (United Kingdom: Edward Elgar Publishing, 1999).

[6] Steven Horwitz, Microfoundations and Macroeconomics: An Austrian Perspective (United Kingdom: Routledge, 2000).

[7] Some of the criticisms presented here have already been laid out in a forthcoming journal article: Phillip Bagus and David Howden, “Monetary Equilibrium and Price Stickiness: Causes, Consequences, and Remedies,” Review of Austrian Economics.  I do not support all of Bagus’ and Howden’s criticisms, nor do I share their general disagreement with free banking theory.

[8] Yeager 1997, pp. 222–223.

[9] Laurence Ball and N. Gregory Mankiw, “A Sticky-Price Manifesto,” NBER Working Paper Series 4677, 1994, pp. 16–17.

[10] Horwitz 2000, pp. 12–13.

[11] Yeager 1997, p. 104.

[12] Yeager 1997, p. 223.  Yeager quotes G. Poulett Scrope’s Principles of Political Economy, “A general glut — that is, a general fall in the prices of the mass of commodities below their producing cost — is tantamount to a rise in the general exchangeable value of money; and is proof, not of an excessive supply of goods, but of a deficient supply of money, against which the goods have to be exchange.”

[13] Joseph T. Salerno, Money: Sound & Unsound (Auburn, Alabama: Ludwig von Mises Institute, 2010), pp. 193–196.

[14] This is Menger’s theory of imputation; Carl Menger, Principles of Economics (Auburn, Alabama: Ludwig von Mises Institute, 2007), pp. 149–152.