Loans and falling prices and wages

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    First, I must confess I havn´t gone trough the whole course material. Not even started yet, to be honest (im doing the course on western history first). But from my earlier reading of articles about Austrian ecenomics I have learned that most think, under a system of Full Reserve Banking and commodity money (gold bullion), that the amount of money in circulation would be more constant than it is under the present monetary system (some expansion would occur in a system based on gold bullion because more gold would be digged out of the ground).

    So, okey, I accept that the amount of money would be far less expansive under such a monetary system. The Austrian economists also state that prices for products such as food, clothing, computers and mobile phones would tend to fall in a well-functioning economy. This would be a natural because productivity would rise because of improvements in the methods production. But, if the amount of money in the “system” is constant, and the number of people are growing this should also affect the wages being payed to wage earners. I asked this question to a person knowledgeable about Austrian economics and he told me that falling wages is not a problem. He made the point that altough my wage may go down in nominal terms, I would still be better of because, in real terms my lower nominal wage would still enable me to buy more products because the prices would also fall and more rapidly than my wage.

    I understand this way of thinking and the distinction between real wage and nominal wage-level. But now, this problem I have, is if we take the situation of most wage-earners. Most of us have a large loan (in my case to finance my studies and my apartment). Now my loan is today approximatly at the level of 125 000 $. My current wage is, after tax, 3 400 $. The terms of the contract I have with my bank is that I will have to pay back my loan according in its full nominal value.

    What would happen to me in a system with a constant money supply and falling wages and prices on consumer goods? I would, off course, benefit from being able to buy consumer products at a lower price. But if my wage, altought in nominal terms only, would drop down it would put me in deeper depth than im currently in over time because my loan is set in nominal terms and no clause in the contract is to be found were it states that the amount I own my lender should be adjusted to real terms.

    Can you understand my question here? I may not be very clear about it. My inability to write proper english is due to the fact im residing in Sweden and english is not my mother tounge…

    I would be glad to read som good comment on this matter!


    Note: I mentioned my wage is 3 400 $ after tax. That is monthly wage. So my wage for a whole year of work is 40 800 $.


    That is the problem with borrowing money. In a deflation people complain that their income is not paying off their loan fast enough because when they borrowed there was more money going around before they took out that loan. Then deflation contracted the money supply after the date the loan was taken out, meaning less units of currency to go around. Your loan stated you will pay back a certain amount no matter what happens in the future. Your contract does not state it can be adjusted due to deflation, in short you better pray deflation does not come until after you pay off the loan. If inflation happened you wouldn’t care because that contract says you owe this amount, but you would be getting more units of currency through the expansion of the money supply. That would make it easier for you to pay off that loan. In other words be damn sure you can afford to pay off the loan, and saving should be number 1 in your things to do everyday. It’s just easier to use your own money than somebody else’s money due to uncertainty of the future.


    Ramlajh, this is a common objection to commodity money. The objection boils down to this, “Steady price deflation [a decrease in nominal wages/prices] will crush those who have debt because they will be paying back their loans with money that is worth a lot more than it was when they took out the loan.”

    In current U.S. society, deflation would cause widespread default on debt obligations. But there is no reason to believe that lenders would not negotiate partial defaults with borrowers as to avoid not getting paid out at all.

    Bryan makes a solid point above. In current society we expect inflation and make borrowing decisions based on that expectation. However, if there were to be a change to commodity money, then people would expect deflation and those expectations would be factored into the interest rates of loans.


    Pretty depressing answers. What would you tell someone who suggested that a monetary system with inherently deflationary feautures is rigged in favour of holders of vast amounts of capital? In what way would you say that a stable currency which works constantly toward deflation is in the best interests of the “common man”?


    Don’t worry Ramlajh, it’s not as depressing as it looks. Liberty is always the answer. The alternative to a “monetary system with inherently deflationary features” is an inflationary monetary system that breeds the boom and bust and crony capitalism we have rampant today.

    Also, this 40 page or so essay is right on point.


    The money stock would not be constant in a market economy with commodity money. Money production would be regulated by profit. If the purchasing power of money was anticipated to rise, then entrepreneurs could profit by producing more commodity money. This process would moderate any price deflation.

    People are also free to select which commodity they want to use as money. If they thought gold would be less suitable because it would result in modest price deflation and thereby raise the problem of appreciating real value of debt, they could chose silver instead. In fact, silver (which is not as restrictive in production) not gold is the most widely used commodity money in history. People could even contract their debts in silver and use gold for other purchases. Using more than one commodity as money is called a parallel standard, which has historical precedent as well.


    Thank you all for your informative answers. I will, in time, read the essay recommended in this thread. Just one further question. Is it correct of me to think that the monetarist, the Chicago School of thought so to speak, differs from the Austrian School in that they think money should be regulated by government instead of the market. Is this the key difference between these schools of economic thought on the matter of money. And is this the key critique of the Austrian school against the monetarist? That is, their faith in the governments ability to outdo the market is fallicious and that we cannot entrust government with taking care of monetary matters?


    Here is Murray Rothbard on Milton Friedman:

    As you can see, differences on money is just part of the distinction between the two schools.

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