Et Tu Ramesh

http://www.nationalreview.com/articles/263668/not-enough-money-ramesh-ponnuru?page=1

My daughter was born last week, and as I sat holding her, staring at her perfect little nose, hands, and toes, I immediately began thinking of how angry quantitative easing makes me. In this post, I turn my attention to the sophistry of the right. In this case, its The National Review's Ramesh Ponnuru ("RP"), a writer and man I generally respect, but who erroneously argues in favor of monetary expansion. Unlike Krugman, he's not dishonest. Unfortunately, like Krugman, he doesn't understand the production of real wealth very well. Surprisingly, he downplays the ways in which inflation is eroding Americans' lives. Most disappointingly, like Krugman, he seems to share the belief that somehow countries can get wealthier buy doing painless things like borrowing and/or printing money. Alas, it is not that easy. As always, real wealth can only come from productive work and savings.

Like all mainstream economists, RP wrongfully conceives of the economy in terms of equations. This is a mistake for a lot of reasons, most notably because he makes the mistake of confusing a purely mathematical equation and an equation that purports to describe an external (i.e. non-mathematical) reality. For example, the equation x+7=12 is a purely mathematical equation. As this equation has no relationship to the real world (i.e. it does not purport to describe a reality), this equation is neither true nor false -- its simply a self-contained piece of logic. In fact, its equally valid to sax 2x+7=12.

In contrast, other equations are not creatures of logic, but rather describe a physical reality. The simplest physical equation is F=MA. While mathematical, this equation describes a physical reality. If I throw a baseball, the force I impart is F=MA, not F=2MA. Unlike X+7=12, F=MA is not a purely mathematical statement; it describes real-world, physical activity. This is a crucial distinction to keep in mind as you read RP's piece.

The core of RP's argument is his belief that printing money can lead to real wealth:

MV=PY. What that means is that the money supply (M) times the speed with which money changes hands (V, for velocity) must equal the price level (P) times the size of the real economy (Y). If velocity holds constant and the money supply goes up, either prices must go up or the economy must expand or both. If, on the other hand, velocity drops — if people have an increased desire to hold money balances — then either prices must drop or the economy must shrink or both.

This equation on its face is wrong. If it were true, the economy could grow infinitely large if people committed to constantly spending money and the Fed printed unlimited amounts of money, something that is demonstrably false.

Even assuming, arguendo, that this equation is correct, RP's conclusion is still wrong. He makes the erroneous assumption that the equation MV=PY is purely mathematical, and not constrained by extrinsic cause and effect. However, the equation MV=PY is not a logical equation, but an equation that purports to describe real-world phenomena, namely economic activity. As a consequence, this equation is constrained by real-world cause and effect.

The baseball example is illuminating. Imagine that I throw the baseball as hard as I can, and I impart 30 Newtons of force. In other words M x A = 30. It is beyond dispute that if instead of a baseball, I threw a ball made of concrete, which had 2x the mass of a baseball, I wouldn't impart 2x the force -- I still only have 30 Newtons of force in my arm. When F is a fixed physical reality (i.e. how hard I physically can throw the ball), simply doubling M doesn't make me stronger. The equation doesn't change reality, it can only reflect it.

By citing the equation MV=PY for the proposition that an increase in M will lead to an increase in Y, RP implicitly assumes that Y is a dependent variable that can be increased by increasing M or V. But, as the baseball example shows, equations that describe real-world phenomena can't be manipulated; they are always tethered to a physical reality.

RP's implicit assumption that Y is a dependent variable that M can dictate is thoughtless, and RP does not try to defend it. In the same way that F isn't dependent on M, but rather on how strong the muscles in my arm are, Y is determined by the efficiency with which real goods are produced. Of course, it is possible that Y is a dependent variable, and is dependent on M, but this is not a mathematical truth or axiomatic -- it must be demonstrated.

Unfortunately, RP doesn't ever support his implicit contention that Y is a dependent variable, or discuss the mechanics of how his proposal would actually increase real wealth. His argument is based on the totally baseless assumption that Y is a dependent variable of M, and on the basis of this assumption, argues that increases in M will increase Y. It is in fact totally circular.

Of course, supporters of RP's position will contend that, even though he did not in any way support it in the article, RP's assumption is correct, and an increase in M will increase Y. This contention is wrong, and will be discussed in my next post.