There has been considerable throughput of gold in western capital markets, with substantial buying from all round the world following the April price crash. The supply can only have come from two sources: the general public, or one or more governments. It really is that simple. Two months later the gold price has only partially recovered, so physical supplies have continued to be made available. Physical demand cannot have been entirely satisfied by ETF liquidations, confirming governments are involved. This article looks at the dynamics of the gold market around this event and the implications.
While the investing public in the western nations has been generally stunned following the April price smash, demand from Asia is running at record levels, illustrated in the chart below, which is of physical gold deliveries on the Shanghai Gold Exchange. (Thanks due to @KoosJansen for pointing me to the data on the SGE’s Chinese website).
The increase in deliveries for April and May was spectacular, totalling 460.5 tonnes, with the week ending 26 April alone seeing phenomenal deliveries of 117 tonnes. In addition, according to the Economic Times,India imported 142.5 tonnes in April and 162 tonnes in May, compared with an average monthly rate of 86 tonnes in Q1 2013. Therefore these two countries imported 765 tonnes of gold in two months, before considering any unofficial imports or their government purchases in foreign markets. The rest of Asia, from Turkey to Indonesia would certainly have stepped up their demand for gold as well, as did the western world itself for physical metal as opposed to paper entitlements.
The table below puts this into context.
A prefatory note about the statistics in this table: there is no single defined source of statistics on gold movements, and there are considerable variations in the same numbers reported by different organisations. The figures in the table above can only illustrate bullion flows. I have sourced the statistics from official sources where possible. The cash-for-gold business has had the easy pickings by now, so an assumption that this is about 600 tonnes per annum is I believe cautiously over-generous. It is based on a speech made by Jeffrey Rhodes of INTL Commodities DMCC to the LBMA in 2010, when he identified scrap supply as 583 tonnes in North America and Europe, whose central banks are in the gold suppression business. At that time, 1,091 tonnes were recycled in the East, including Turkey. Since the Chinese, Russian and other gold-producing governments of Central Asia retain most if not all of their domestically mined gold amounting to over 700 tonnes, there is less than 2,000 tonnes of free mine supply annually available for global markets, based on US Geological Survey figures.
Looking at the bottom line for 2012, there were only 87 tonnes of gold supply for the rest-of-the-world, after Asian and Russian central bank and global ETF purchases. In other words, there must have been a severe deficit overall, which can only have been covered by central bank sales.
About 150 tonnes of ETF gold were liquidated in Q1, providing temporary relief until the Cypriot crisis, when concerns over the security of large deposits in eurozone banks prompted a flight into physical gold, but interestingly, not into ETFs. This was because there were escalating systemic concerns over having physical gold and currency deposits with European banks, while at the same time portfolio investors were worried that the 12-year bull market might have ended.
From the point of view of the western central banks, as well as the bullion banks with short positions on Comex, in March the alarm bells must have been ringing loudly. Chinese demand was accelerating and there was an increasing likelihood that ETF liquidation would cease if the gold price stabilised. If that happened, as the table above clearly shows, an epic bear-squeeze would likely develop, fuelling a rush into gold and potentially bankrupting many of the bullion banks short in the futures markets and/or offering unallocated accounts on a fractional reserve basis.
Therefore, investors had to be dissuaded from buying gold, otherwise the ensuing crisis would not only cause a market failure that could spread to other derivatives (particularly silver), but it would come at the worst possible time, given the coincidental programme of monetary expansion currently being undertaken by all the major central banks.
The reasons for governments to intervene on the side of the bullion banks were therefore compelling. As one would expect, the intervention was well-timed: on Friday 12 April two large sell orders of 100 and 300 tonnes were placed on Comex, clearly designed to do maximum damage to the price, and setting it up for all remaining stops to be taken out the following Monday. Furthermore, central banks were prepared to supply physical gold to keep the price from recovering. We know this because lower prices generated a surge in private demand, not only in China and India, but from everywhere. The only possible supply, other than inadequate ETF liquidation, is from governments.
India and China have absorbed enough gold in the last two months of April and May to leave the rest of the world in a supply deficit, requiring matching sales of western government gold to continue to suppress the price.
We now know for certain that government-controlled gold has been used to defuse a developing crisis in gold markets that had the potential to destabilise bullion banks, other derivative markets and ultimately the whole fiat currency system. We have seen the surge in demand for physical gold, which is the consequence of sharply lower prices. Realistically, the priority has been to ensure such a crisis is avoided, rather than for the price of gold to be continually suppressed.
The difficulty for the casual observer is compounded by the available information being one-sided. We are all painfully aware of both the losses inflicted on investors and their loss of faith in gold at a time when other investment media, such as stocks and bonds, have been doing well. Concealed from us is the real financial condition of the banks and governments themselves, which is the fundamental reason for owning gold. We are acutely aware of the sellers’ pain and only dimly aware of the buyers’ motivation.
Nervous western investors in a market of 160,000 tonnes are in truth a small part of the whole, particularly since gold has been migrating from the west to the east where it has been more valued ever since the 1970s oil crisis. More fundamentally we know that the stock of gold grows at about 1½% annually in line with global population growth. We also know that central banks everywhere are expanding their balance sheets at an accelerating rate. The disparity between the rate of growth for gold and paper currencies will certainly lead to increased tensions between precious metals and currencies generally, and it is this that will drive future demand for gold, not whether western investors think it is in a bull or bear market.
A second point about the market being 160,000 tonnes and not just the sum of mine and scrap supply is that the market is far bigger than western governments’ gold reserves. Gold held by them is officially about 19,000 tonnes, but it may well be only half that, or 5% of the aboveground stock, when unrecorded leasing and selling over the last 25 years are taken into account. The ability of central banks to contain a global surge in gold demand such as that which followed the April price-crash and continuing to this day is therefore limited.
But this is only a part of the story. There are the factors concealed from us, such as the buying opportunity given to gold-friendly governments and sovereign wealth funds, both with surplus dollars, as well as the appetite for gold from the growing ranks of the Russian and Asian mega-rich. There are factors known to the financially savvy, such as the growing instability of the Indian rupee and other emerging market currencies, the increasing systemic risks in eurozone banks with the threat posed to deposits, and the revenue shortfalls that force governments to raise money by printing their currencies at an increasing pace: all will impact the gold market in coming months.
These and other systemic problems are deteriorating. A potentially destabilising crisis in the gold market from runaway prices has been defused by allowing the bullion banks the space to square their books. There can be no other realistic objective in supplying government-owned gold into the market. As to the embarrassment of the gold price rising at a time of accelerating money printing – that will have to be accepted, presumably emphasising the official line, that the gold price is irrelevant to a modern economy.
Episode 131: GoldMoney’s Andy Duncan talks to John Embry, Chief Investment Strategist at Sprott Asset Management (www.sprott.com), about the “Great Gold Takedown”, the road to hyperinflation, and the Orwellian nature of government economic information.
Along the way they discuss the possible financial fallout from the recent Bilderberg meeting and other clandestine conferences, good sources of truthful information for GoldMoney clients, and when western central banks might run out of precious metal.
They also touch upon black swans, how to remain motivated in the possible face of gold price suppression, and the realistic potential of future world monies based upon gold.
I don’t think I’m adding anything original but as I understand things, George’s position rests on two claims. (1) In an “ideal” system (i.e. free banking) there would be an increase in the money supply in response to an increase in the demand to hold it. In other words the banking system would ensure that MV is stable. (2) In the present system, the costs of attempting to “do nothing” are higher than the costs of attempting to simulate a free banking system, even though you can’t do this perfectly. Therefore if V increases the Fed should increase M. Hence there is “a case” for QE.
Many Austrians deny the first point, and so it is obvious that they would reject the second. Peter Boettke is right to say that the second point doesn’t necessarily follow from the first (although I’m not totally sure if he fully agrees with the first point himself). But – and let’s take it as given that the first point is accepted – here are a few things to consider when thinking about the second point:
As George says, the Fed is always doing something. “Do nothing” is not an option.
If we don’t possess the knowledge required to know when the Fed should increase M, how can we possess the knowledge to declare that they were increasing it too much during the boom? If we literally have no idea whether money is too tight or too loose, surely this dramatically reduces the plausibility of using ABC as an explanation for the underlying cause of the crisis?
NGDP is a better way to infer the monetary stance than consumer prices, or real GDP. Therefore thinking in terms of NGDP targets as opposed to inflation targeting is worthwhile.
Market monetarism seeks to replace all discretionary monetary policy with a very simple rule. Targeting NGDP expectations is a contemporary version of a Friedman rule and also can be seen as a step towards free banking. Of all the monetary policy rule on the table, it’s hard to beat. *If* you want to have some policy relevance, this is where the action is. It directly leads to an acknowledgement that monetary policy should be neutral, and that it should distinguish between productivity shocks and reductions in AD. It would be a massive improvement over the status quo, albeit we’d remain a long way from the ideal.
Even if you think there’s a case for the Fed to increase M, there’s a number of ways to go about doing it. QE is not necessarily the best. The likes of George, Steve Horwitz, etc, have been very clear from the start that QE as implemented by the Fed has been an error. And particularly on the Robust Political Economy grounds that Pete raised. There are two questions to consider: by how much do you want to increase M? and how? QE as practiced has dramatically increase Fed discretion and could be opposed on those grounds alone. It’s also not been accompanied by an effective communication strategy, meaning its supposed effectiveness has been curtailed. I’ve been in print myself arguing against it on both grounds (i.e. undesirability, and that it will fail on its own terms).
Finally, I sense that Pete (and many other Austrians) accept the basic arguments put forward above but just can’t bring themselves to be seen to be endorsing any action of a government agency. The analogy I use here is that the state is like a wife beater. We all see the damage being done but for whatever reason the person being beaten always offers forgiveness and a belief that things will improve over time. In which case the bystander/economist has two options. You could try to minimise the harm being caused. Or you could try to engineer an event so catastrophic she finally confronts the problem.
Maybe if the Fed tried to “do nothing” in 2008 there would have been such a crisis that faith in central banking would be completely shattered, and we would usher in a new era of free banking. In which case maybe +10% unemployment and a breakdown in monetary calculation “would be worth it”. But holy shit! Maybe if that had occurred it’d have been used as a reason to have an even more centrally planned economy, because instead of putting forward the ideas of liberty in a pragmatic, policy-oriented public debate, our best and brightest are too busy seeking the luxury of irrelevance!
I say this as someone who’s turned down opportunities to discuss the evils of central banking on TV because I know full well an uncharitable audience would fail to understand that you simply cannot spent 10 minutes defining terms and explaining caveats in a brief live interview. Bravo to anyone who has the courage to state their case publicly.
I can sleep at night because although people may mistake me as a Keynesian, a Monetarist, an endorser of monetary socialism, etc, my criticisms are more effective if they are informed criticisms; I find common ground with intellectual opponents where it exists; I have “spoken truth to power”; and I’m staying true to “good” monetary theory as I understand it. Such attacks say more about deficiencies in their knowledge than it does mine.
I have great respect for Joe Salerno and have learnt a lot from him. But I think George is right to say “there is a case for QE” and I think that needs to be opened up and discussed, not shouted down.
Anthony J. Evans is Associate Professor of Economics at ESCP Europe Business School, and Founding Fellow of The Cobden Centre | Contact us
14 June 13 | Category: Economics | 5 comments
OUTSPOKEN Bank of England official Andrew Haldane warned yesterday that the bursting of a bond bubble is the biggest threat to the world’s financial stability.
Haldane, the Bank’s executive director of financial stability, told the Treasury Select Committee that central banks’ massive asset-buying programmes have created significant risks.
“If I were to single out what for me would be the biggest risk to global financial stability right now, it would be a disorderly reversion in government bond yields globally,” Haldane told the MPs.
“We’ve intentionally blown the biggest government bond bubble in history. We need to be vigilant to the consequences of that bubble deflating more quickly than we might otherwise have wanted.”
It’s at once terrifying and wonderful to see the conversation about the economic crisis move in this direction. Terrifying because it looks increasingly like those of us who have been talking about the massive economic disruption caused by central banks are correct. Wonderful because at last the Bank’s most courageous official has made this explicit.
The FT recently reported on its front page, “Some of the smartest money in America is getting out of US government debt.” Unfortunately, big players in markets like central banks cause herding. It therefore remains to be seen whether it is possible for the bond bubble to deflate slowly.
In any event, interest rates will rise unless central banks take yet further action. The medium term consequences for our system of money, the welfare state and society are likely to be profound.
Earlier this month, in an article for “Project Syndicate” famous American economist Nouriel Roubini joined the chorus of those who declare that the multi-year run up in the gold price was just an almighty bubble, that that bubble has now popped and that it will continue to deflate. Gold is now in a bear market, a multi-year bear market, and Roubini gives six reasons (he himself helpfully counts them down for us) for why gold is a bad investment. Roubini does not quite go so far as to tell his readers that there is no role whatsoever for the yellow metal. Investors should have a “very modest” share of gold in their portfolios, as a hedge against extreme risks, which, the good professor assures us, are almost so negligibly small that they are “irrational fears”, really, but beyond that there is little reason to bother with gold.
Interestingly, “very modest” is indeed a good description of gold’s share in the global asset mix. According to some studies gold accounts for only around 1 percent of global asset holdings. In terms of asset breakdown we already are where Roubini thinks we should be. So why bother? Those of us – such as yours truly – who hold a more pessimistic outlook as to the efficiency of current policies and the sustainability of the current monetary infrastructure, and who accordingly hold a bigger share of their wealth in gold, are evidently “paranoid”, and as they now reap the deserved reward for their dreadful negativity courtesy of a declining gold price, why not ignore them? It is, after all, a tiny minority. But it is evident from Roubini’s essay that he not only considers the gold bugs to be wrong and foolish, they also annoy him profoundly. They anger him. Why? – Because he thinks they also have a “political agenda”. Gold bugs are destructive. They are misguided and even dangerous people.
Roubini’s case against gold
But let’s first look at his arguments for a continued bear market in gold. They range, in my view, from the indisputably accurate to the questionable and contradictory to the simply false and outright bizarre. Here is the list (with some of my commentary. Apologies to Professor Roubini.):
1) Gold is only useful in extreme economic scenarios (such as 2008/2009) but even then its price is highly volatile (and so it was in 2008/2009).
2) Gold is only useful when there is risk of rising inflation. Despite unprecedented policy measures, such as multiple rounds of QE, there is no inflation, according to Roubini. – Why is there no inflation?- Because the newly created money is stuck in the banking system and the wider financial system where it finances a happy merry-go round of asset trading without boosting broader monetary aggregates. Outside finance (and government, I might add) nobody wants to take on more debt. The normal transmission mechanism is not working. – Additionally, Roubini makes some heroic assumptions about there being no pricing power and no wage inflation.
3) Gold produces no running income and will thus be at a disadvantage in a recovering economy when equities and bonds do better. – Wait a minute. Recovering economy? Where did that come from? I thought none of the monetary stimulus was getting through to the real economy and hence failed to ignite inflationary pressures? How can it then stimulate real activity? Or are the two somehow unrelated?
4) Gold does best when interest rates are low or negative but the present recovery – recovery, again! – will allow central banks to unwind their present easy monetary policy stance and to hike interest rates. –- OK. Good luck with that. But again we are asked to take the present talk of recovery at face value. On the one hand Roubini cites ubiquitous deleveraging pressures, “lack of pricing power” and “excess capacity” (these are his words!) as reasons for why the extraordinary expansion in base money supply is not translating into money growth in the wider aggregates that usually drive the wider economy, and why therefore standard inflation measures remain benign and, on the other hand, evidently sees none of this as an obstacle to the self-sustained recovery story. — And if the economy indeed does recover without the help from easy money then, maybe, monetary policy is easy for other reasons, such as keeping an overstretched banking system from collapsing. In that case, better growth momentum as such may not be sufficient to allow central bankers to exit their present policy program.
5) Fears of sovereign default have been driving people into gold but now the greater risk is that struggling sovereigns may sell their gold holdings. – This is potentially a risk but I would counter that while selling from official sources could affect the gold market in the short-term, liquidating the family silver (no pun intended!) and removing the remaining smidgeons of hard assets at the bottom of the inverted pyramid of the über-leveraged paper money economy and replacing it with government IOUs is not going to instil a lot of confidence on the part of the public. Gold liquidation is a further sign of stress, of a check-mated policy elite running out of options, and the public may end up scooping up willingly whatever desperate politicians sell. But I guess that reasonable people can disagree on this point. – But now it gets really interesting:
6) In large parts the gold bull market was the work of, wait for this, “extreme” political conservatives, of the “far-right fringe” and conspiracy theorists. That hype is now coming undone. According to Roubini gold is not simply another asset but an indicator of political extremism, of an unhealthy mistrust of the established order. Roubini: “These fanatics also believe that a return to the gold standard is inevitable as hyperinflation ensues from central banks’ ‘debasement’ of paper money.” – Well, I guess it is time for the IRS to conduct a couple of customized tax audits!
Monetary policy prevents economic healing
Roubini does not provide much explanation for his claim that we are now in a self-sustained recovery that will allow central bankers to exit the extreme policy positions they adopted in recent years. He seems to rely on the healing forces of the market. I am the first to agree that these forces do exist in a capitalist economy and that they are incredibly powerful. That is why the market should always be left to its own devices, be allowed to unwind and liquidate accumulated dislocations that are now barriers to renewed growth, and to bring the economy back into balance. But these are precisely the very processes that present monetary policy sabotages with all its might: zero interest rates and unlimited bank funding, plus ongoing asset price manipulations, numb the market’s power to cleanse and heal and re-adjust, and instead allow banks and other financial operators to continue in their policy of pretend and extend, to keep on their books underperforming, bad or even toxic assets at unrealistic prices. Policy makers have to decide whether they want the market to operate its healing powers (even if some of the healing imposes near-term pain on the patient), or whether they rather trust their own powers to continuously drive the economy, imbalances and all, to higher levels of performance with their money-printing, market manipulation and deficit spending. We know which path they have followed so far, and that is why placing your hope on self-healing market forces is naïve. Strangely, Roubini himself has on numerous occasions warned against a strategy of kicking the can down the road and has repeatedly warned of new credit bubbles. I wonder which Roubini wrote this article.
At the core of Roubini’s argument is a paradox: easy money – the monetary ‘stimulus’ – is stuck in the banking industry and the wider financial system, and that is his explanation – together with excess capacity, deleveraging and the absence of ‘pricing power’ – for why the standard measures of inflation – consumer price inflation in particular – have not risen more dramatically. Unless you are a derivatives trader or a hedge fund manager you have not seen any of the money. But when you will, finally, believe me, then the prices that matter to you will also go up. Roubini cannot have it both ways: easy money has no effect on inflation but a stimulating one on growth – not even his funny New Keynesianism can square that circle.
But the real criticism of present policies is not that they will lead to instant hyperinflation – I believe they will eventually lead to much higher inflation and probably hyperinflation – but that they don’t solve anything but make economic imbalances much worse. They do not have an exit, and this is why they will ultimately destroy money. Roubini is overstating the ‘healing’ argument considerably, and in the course makes some big blunders: “Ongoing private and public debt deleveraging has kept global demand growth below that of supply.” – This is evidently not supported by the facts. As I have argued before, private sector deleveraging is minor, and in most countries, governments are issuing massive amounts of new debt, certainly in the US, the UK (contrary to what the public debate there would make you believe), and Japan.
Are owners of gold ‘extremists’?
But what is most worrying, and most disturbing, is Roubini’s pathetic attempt to label gold bugs political extremists. Central banks run policies today that only a few years ago would have set the average middle-of-the-road central banker’s hair on fire. Of course, the public is worried, scared and skeptical. Because the political and monetary elite, the establishment of which Roubini – senior economist for the Council of Economic Advisors under Bill Clinton and senior economic advisor to Timothy Geithner when at the United States Treasury Department – is a member, has lost the plot. The paper money bureaucracy has painted itself into a corner. The public has very good reasons to be worried, skeptical and scared.
Early in his article, Roubini makes the following observation: “During the global financial crisis, even the safety of bank deposits and government bonds was in doubt for some investors.” [my emphasis.] – What does he mean, for some investors? Banks did fail and governments did go bankrupt in the crisis. Was that just a figment of the imagination of some investors? – The only reason that not more banks went under (yet) and more governments went bankrupt is unlimited money printing. Unless monetary policy changes meaningfully we won’t even know which entities are truly solvent and which are not. And then we might find out the hard way.
Of course, people who are already predisposed to skepticism towards the political elite and their ongoing meddling with the free market will be more inclined to buy gold. But that only makes them libertarians, or individualists, or simply people who are suspicious of power and politics. I have met many of them and have yet to meet anyone who deserves the label ‘far right’, with all the connotations that Roubini invokes here, deliberately, I assume. — I am the first to acknowledge that the pro-gold community – and it is not even a real community – has its fair share of eccentrics but the majority of those who piled into gold is simply worried about where our unhinged monetary system will take us next – and justifiably so.
Roubini simply resorts to smear tactics. The same approach has been shamelessly employed for many years by Paul Krugman. The idea is to unilaterally determine the acceptable parameters of enlightened economic debate. The high gospel of John Maynard Keynes is not to be questioned, and the wisdom of having highly-trained academicians running a central bureaucracy in charge of monetary policy, administratively setting interest rates, creating bank reserves at will, and manipulating the prices of a growing number of assets to the benefit of the greater good, a system that not only did not exist 50 years ago but that back then nobody even advocated, is not to be challenged under any circumstances. Those who do are not worthy of debate. They are evidently members of the Montana Militia. They are crackpots and dangerous subversives. As Roubini stated: advocates of a gold standard are fanatics.
This is, of course, utter gibberish. A well-articulated, rational and sophisticated theory exists for why paper money systems are unstable and why they fail, and why hard money systems work better. The Austrian School of economics explains this convincingly. Its leading intellectual light was Ludwig von Mises (1881 – 1973) – urbane, sophisticated, highly intelligent, and a man of principle, one of the greatest economists of the twentieth century, who lived and taught in Vienna, Geneva and New York. – Not your average backwoodsman.
Roubini may be right on one thing: maybe gold will go down to $1,000. So what? – It won’t stay there. For whatever happens next to the gold price, or whatever the Fed does next, Roubini’s over-geared paper money economy will not survive in its present form.
In the meantime, good luck with that ‘exit strategy’!
In his Financial Times article on June 4th the FT columnist Martin Wolf praised Ben Bernanke for saving the US economy and the world from another Great Depression. He dismisses various critics of Bernanke as lacking in imagination as to what would have happened had Bernanke and the US central bank not acted.
Central banks, including the Fed are doing the right thing. If they had not acted as they have over the past six years, we would surely have suffered a second Great Depression.
According to Wolf, the central bank’s role is to stabilize the economy against financial upheavals. He holds that the source of these upheavals is the credit driven private financial sector of the economy. On this way of thinking the instability that is generated in the private sector can culminate in a full blown economic crisis which disrupts the monetary flow and this in turn weakens economic activity and economic growth. (A weakening in the monetary flow weakens the demand for goods and services and in turn undermines incomes).
The solution to the weakening in the monetary flow is aggressive monetary pumping by the central bank to restore the flow.
Now if the central bank fails to do its job and doesn’t intervene, according to this way of thinking, this could lead to an implosion of the monetary flow and in a collapse in economic activity and economic growth.
A major manifestation of such collapse is a sharp fall in economic activity. It is for this reason that once a fall in economic activity is observed the central bank must step in aggressively to reverse the implosion in the monetary flow and economic activity.
Hence all the critics of the Fed that blame it for excessive monetary pumping since 2008 don’t really know what they are talking about, argues Wolf.
Granted there is a cost involved in such intervention, but consider the other alternative of not intervening – i.e. the Great Depression.
On this logic America owes a lot to Bernanke for if not for his quick response to the emerging implosion in the monetary flow by now the America would have been in a deep economic crisis.
In a lecture given at the George Washington University on March 27, 2012 Ben Bernanke had already anointed himself as the savior of the American economy before waiting for Martin Wolf.
The Chairman of the Fed said that the US central bank’s aggressive response to the 2008-2009 financial crisis and recession helped prevent a worldwide catastrophe.
According to Bernanke various economic indicators were showing ominous signs at the time. After closing at 3.1% in September 2007 the yearly rate of growth of industrial production fell to minus 14.8% by June 2009.
The yearly rate of growth of housing starts fell from 20.5% in January 2005 to minus 54.8% in January 2009.
Also, retail sales came under severe pressure – year-on-year the rate of growth fell from 5.2% in November 2007 to minus 11.5% by August 2008.
The unemployment rate jumped from 4.4% in March 2007 to 10% by October 2009. During this period the number of unemployed people increased from 13.389 million to 15.421 million – an increase of 2.032 million.
In response to the collapse of key economic data and a fear of a financial meltdown the US central bank aggressively pumped money into the banking system. As a result the Federal Reserve balance sheet jumped from $0.884 trillion in February 2008 to $2.247 trillion in December 2008. The yearly rate of growth of the balance sheet climbed from 1.5% in February 2008 to 152.8% by December of that year. Additionally the Fed aggressively lowered the federal funds rate target from 5.25% in August 2007 to almost nil by December 2008.
Despite this pumping the growth momentum of commercial bank lending had been declining with the yearly rate of growth falling from 11.9% in January 2007 to minus 5.3% by November 2009. As a result of the fall in the growth momentum of lending the growth momentum of money supply would have followed suit if not for the Fed’s aggressive pumping to the commercial paper market. This pushed the yearly rate of growth of our measure of US money supply from 1.5% in April 2008 to 14.3% by August 2009.
In his speech Bernanke blamed reckless lending in the housing market and financial engineering for the economic crisis. He also acknowledged that the supervision of the Fed had been inadequate.
According to Bernanke once the crises emerged the Fed had to act aggressively in order to prevent the crisis developing into a serious economic disaster.
The Fed Chairman holds that a highly accommodative monetary policy helps support economic recovery and employment. We hold that various reckless activities in the housing market couldn’t have emerged without the Fed’s own previous reckless policies.
After closing at 6.5% in December 2000 the federal funds rate target was lowered to 1% by May 2004. The yearly rate of growth of our monetary measure AMS jumped from minus 0.9% in December 2000 to 11.5% by December 2001. The strong increase in the growth momentum of money supply coupled with an aggressive lowering of interest rates set the platform for various bubble activities, or an economic boom.
A reversal of Fed’s loose stance put an end to the false boom and put pressure on various bubble activities. The fed funds rate target was lifted from 1% in May 2004 to 5.25% by June 2006. The yearly rate of growth of AMS plunged from 11.5% in December 2001 to 0.6% in May 2007. As it happened the effect of this tightening was felt in the housing market first before it spilled over to other bubble sectors. (A tighter monetary stance slowed down the diversion of real wealth towards bubble activities from wealth generating activities).
Contrary to Bernanke, we suggest that his loose monetary policy didn’t save the US economy but only saved various bubble activities, which came under pressure on account of the tighter monetary stance.
Note the loose monetary stance had been aggressively diverting real funding from wealth generators towards bubble activities thereby weakening the wealth generation process. The only reason why loose monetary policy supposedly “revived” the economy is because there were still enough wealth generators to support the Fed’s reckless policy. Also, pay attention that all the gains on account of the previous tighter stance have been wasted to support bubble activities.
As long as the pool of real wealth is still growing Fed policy makers can get away with the illusion that they have saved the US and the world economies. Once the pool of real wealth starts stagnating, or worse declining, the illusory nature of the Fed’s policy is revealed – note that the economy follows the state of the pool of real wealth. Any aggressive monetary policy in this case is going to make things much worse.
The actions of Bernanke to revive the economy run contrary to the basic principles of running a company. For instance, in a company of 10 departments, 8 departments are making profits and the other 2 losses. A responsible CEO will shut down or restructure the 2 departments that make losses – failing to do so will divert funding from wealth generators towards loss-making departments, thus weakening the foundation of the entire company.
Without the removal, or restructuring, of the loss-making departments there is the risk that the entire company could eventually go belly up. So why then should a CEO who decides to support non-profitable activities be regarded as a failure when Bernanke and his central bank colleagues are seen as heroes that saved the economy?
Bernanke and commentators such as Martin Wolf are of the view that by pumping money the central bank had provided the necessary liquidity to keep the financial system going.
We suggest that this is false. What permits the financial sector to push ahead is an expanding pool of real wealth. The financial sector does not have a life of its own; its only role is to facilitate the real wealth that was generated by the wealth producers. Remember that banks are just intermediaries; they facilitate the flow of real wealth across the economy by means of money (medium of exchange).
By flooding the banking system with money one doesn’t create more real wealth but on the contrary depletes the pool of real wealth. Most commentators are of the view that in some cases when there is a threat of serious damage to the financial system the central bank should intervene to prevent the calamity, and this is precisely what Bernanke’s Fed did.
We suggest the severe threat here is to various bubble activities that must be removed in order to allow wealth generators to get on with the job of creating wealth. If a lot of bubbles must disappear, so be it.
Any policy to support bubbles, be they large banks or other institutions, will only make things much worse. As we have seen, if the pool of real wealth is not there a central bank policy to prop up bubbles will make things much worse, after all the Fed cannot generate real wealth.
Bernanke’s policy, which amounts to the protection of inefficiency i.e. bubble activities, runs the risk of generating a prolonged slump with occasional rallies in the data. It could be something similar to Japan (that Bernanke himself has in the past criticized).
Summary and conclusion
We can conclude that, contrary to various commentators, Bernanke’s loose policies didn’t save the US economy from a depression but have damaged the process of real wealth generation.
Bernanke’s loose policies have provided support to bubble activities, thereby destabilizing the economy. So in this sense his policies have saved the bubbles, thus undermining wealth generators. We suggest that the more forceful the Fed’s response to various economic indicators is the more damage this does to the pool of real wealth. This runs the risk that at some stage the US could end up having a stagnating or worse, declining, pool of real wealth.
If this were to occur then we could end up of having a severe economic slump. If any one needs examples in this regard have a look at countries such as Greece, Spain and Portugal.
Over a prolonged period of time the policies of these countries (an ever growing government and central bank involvement in the economy) have likely severely damaged the heart of economic growth – the machinery of wealth generation. Again, if the pool of real wealth is to become stagnant, or worse, starts declining, any attempt by the Fed to make things better is going to make things actually much worse by depleting the pool of real wealth further.
Dr Frank Shostak is a leading Austrian economist and director of Applied Austrian School Economics Ltd, which aims to assess the direction of various markets using the Austrian School methodology. AASE aims to make Austrian economics accessible to businessmen. | Contact us
12 June 13 | Tags: Ben Bernanke, FT, Martin Wolf | Category: Economics | 5 comments
Both Keynesians and monetarists believe that increased government spending, or more money injected into the economy, is sometimes necessary. The intervention is in the form of unfunded government spending, artificially low interest rates to boost demand for money and bank credit, or a drive to make the currency “competitive” by lowering it. These methods have been tried unsuccessfully time and again, and they must be denounced if we are to understand our true economic condition.
The reason they don’t work can be summarised as both an oversight and a fallacy. The oversight is to look at only one side of a government spending proposal: a new bridge, hospital or school is a visible benefit. What is easily ignored is the cost, which is spread between many individuals’ savings and earnings. If these resources were not redirected, they would be available to consumers to spend as they see fit. This is important, because it is consumer demand that drives innovation and economic progress, not government redistribution.
The basic fallacy is to subscribe to ideas that are consistent with the cost of production, or the labour theory of value, and to try to shoe-horn it into the reality of consumer price subjectivity. The list of economists who have made this mistake is far longer than those that understand the error, including Thomas Aquinas, Adam Smith, David Ricardo, John Stuart Mill and Karl Marx. It is the bedrock of socialist thought, which divides us pejoratively into the exploited and capitalist classes. The truth is very different: the consumer through his choices decides prices and what is made, and any producer that fails to respond goes out of business.
The nub of the problem is mainstream economists do not understand prices. They draw supply and demand curves that illustrate, other things being equal, lower prices stimulate demand. Putting to one side the fact that other things are never equal, that is a reasonable starting point. This is then contradicted by macro-economists who believe that falling prices defer and suppress demand, and moderately rising prices stimulate demand.
Therefore the contradictions start from the most basic level, and from there the errors multiply. Instead of abandoning cost-of-production theories, mainstream economists seek to subsidise producers, either directly or by monetary means. It amounts to a subsidy for businesses that would otherwise fail. Furthermore, successful businesses are encouraged to seek subsidies and discouraged from redeploying their capital into genuinely profitable investment.
Through relentless government propaganda nearly everyone today believes that state intervention is a force for good, but the truth is very different. Government intervention amounts to reducing wages and destroying savings through monetary inflation, while putting prices up. Admittedly, there can be a short-term artificial boost from lower interest rates and monetary expansion, but this is quickly reversed when prices start to rise.
A reasoned analysis of the true effects of government intervention reveals the truth: it comes at considerable economic cost, disrupting economic progress and leaving us all worse off as a result. Is it any surprise that reflation has now finally ceased to even generate short-term benefits?
Episode 129: Andy Duncan has the pleasure to interview former Assistant Secretary of the Treasury, Dr. Paul Craig Roberts.
Andy gets straight to it and asks Dr. Roberts about his view on a manipulated price of gold. Dr. Roberts elaborates on how he sees what has occurred since early April, whom was behind it and the reasons why.
Dr. Roberts sees inherent problems with the US dollar system and expresses grave concerns about the systematic fragility due to excess money printing around the world.
The last couple of weeks have been very interesting. Remember that, certain regional differences aside, Japan has, for the past two-plus decades, been the global trendsetter in terms of macroeconomic deterioration and monetary policy. It was the first to have a major housing and banking bubble, the first to see that bubble burst, to respond with years of 1 percent interest rates, then zero rates, then various rounds of quantitative easing. The West has been following Japan each step on the way – usually with a lag of about ten years or so, although it seems to be catching up of late. Now Japan is the first developed nation to go ‘all-in’, to implement a no-holds-barred money-printing regime to (supposedly) ‘stimulate’ the economy. This is called Abenomics, after Japan’s new prime minister, Shinzo Abe, the new poster-boy of policy hyper-activism. I expect the West to follow soon. In fact, the UK is my prime candidate. Wait for Mr. Carney to start his new job and embrace ‘monetary activism’. Carnenomics anybody?
But here is what is so interesting about recent events in Japan. At first, markets did exactly what the central bankers wanted them to do. They went up. But in May things took a remarkable and abrupt turn for the worse. In just eight trading days the Nikkei stock market index collapsed by 15%. And, importantly, all of this started with bonds selling off.
Are markets beginning to realize that all these bubbles have to pop sometime and that sometime may as well be now? Are markets beginning to refuse to dance to the tune of the central bankers and their printing presses? Are central bankers losing control?
‘Sell in May and go away’
Let’s turn back the clock for a moment, if only just a bit. Let’s revisit April 2013. At the time I spoke of central bankers enjoying a kind of ‘policy sweet spot’: they were either pumping a lot of liquidity into markets or promising to do so if needed, and all of them were keeping rates near zero and promising to keep them there. Some started to consider ‘negative policy rates’. Yet, despite all this policy accommodation, official inflation readings remained remarkably tame – indeed, inflation marginally declined in some countries – while all asset markets were on fire: government bonds, junk bonds, equities, almost all traded at or near all-time highs, undeniably helped in large part by super-easy money everywhere. Even real estate in the US was coming back with a vengeance. And then, in early April, central bankers got an extra bonus: their nemesis, the gold market, was going into a tailspin. I am sure Mr. Bernanke was sleeping well at the time: financial assets were roaring, happily playing to the tune of the monetary bureaucracy, seemingly falling in line with his plan to save the world with new bubbles, while the cynics and heretics in the gold market, the obnoxious nutters who question today’s enlightened policy pragmatism, were cut off at the knees.
But then came May and everything sold off.
However, that is not quite how the media presents it. Here, one prefers the phrase ‘volatility returned’, as that implies that everything could be fine again tomorrow. And it certainly can. Maybe this is just a blip. But what if it isn’t? And, more importantly, what is driving it?
A widely debated theory is that the prospect of the Fed ‘tapering’ its quantitative easing operation, of it oh-so carefully, ever-so slightly removing its unprecedentedly large and more than ever alcohol-filled punchbowl could end the party. There has for some time been concern about and even outright opposition to never-ending QE within the Fed. So there is, of course, a risk (a chance?) that the Fed may reduce or even halt its asset-buying program. (As a quick reminder, since the start of the year, the Fed has expanded the monetary base already by more than $340 billion, and at the present pace, the Fed is on course to create $1,000 billion by the end of the year.)
Ben Bernanke – tough guy?
However, I do not think that markets have a lot to fear from the Fed. Should a pause in QE lead to a sell-off in markets, to rising yields and rising risk premiums, then, I believe, the Fed will quickly revert course once more and switch on the printing press again. The critics inside the Fed will be silenced rather quickly. Remember that most of them seem to argue that additional QE is not needed; they do not appear to reject it on principle. Ultimately, nobody in policy circles is willing to sit on his or her hands when the markets seriously begin to liquidate. The ‘end’ to QE, if it is announced at all, is likely to be just an episode.
The last central banker who had the cojones to take on Wall Street was Paul Volcker. Ben Bernanke, as well as his predecessor Alan Greenspan, have been nothing but nice to the speculating and borrowing classes. Both subscribe to and have, on numerous occasions, articulated the notion that it is part of the central bank’s remit to bring good cheer to households and corporations by lifting their house prices and inflating their stock prices and executive option packages. What the country needs is optimism and what is more conducive to optimism than a rising stock market and happy faces on CNBC? Bernanke declared that boosting financial assets can kick-start a virtuous circle of borrowing, investing and self-sustained growth. David Stockman has aptly called this approach ‘prosperity management’ through ‘Wall Street coddling’. Of course, Greenspan tightened in 1994, and again very carefully in 2005, and yes, both times financial markets caved in. But this only serves to illustrate how unsustainably bloated and dislocated the financial system has become, and how addicted to cheap money from the Fed. I think the Fed will be very careful to reduce the dosage of its drug anytime soon.
Although he didn’t quite put it in those terms, global bond guru Bill Gross, founder and co-chief investment officer at asset management giant PIMCO, seems to see it similarly. In an interview with Bloomberg in the middle of May, he confirmed that he and his team saw “bubbles everywhere”, which certainly implied that everything could go pop at the same time. He also stated that the Fed would “not dare” to do anything drastic anytime soon as the system is so much more leveraged now than it was in 1994, when Greenspan briefly tried to play tough and tighten policy.
My conclusion is this: if market weakness is the result of concerns over an end to policy accommodation, then I don’t think markets have that much to fear. However, the largest sell-offs occurred in Japan, and in Japan there is not only no risk of policy tightening, there policy-makers are just at the beginning of the largest, most loudly advertised money-printing operation in history. Japanese government bonds and Japanese stocks are hardly nose-diving because they fear an end to QE. Have those who deal in these assets finally realized that they are sitting on gigantic bubbles and are they trying to exit before everybody else does? Have central bankers there lost control over markets? After all, money printing must lead to higher inflation at some point. The combination in Japan of a gigantic pile of accumulated debt, high running budget deficits, an old and aging population, near-zero interest rates and the prospect of rising inflation (indeed, that is the official goal of Abenomics!) are a toxic mix for the bond market. It is absurd to assume that you can destroy your currency and dispossess your bond investors and at the same time expect them to reward you with low market yields. Rising yields, however, will derail Abenomics and the whole economy, for that matter.
It is, of course, too early to tell. The whole thing could end up being just a storm in a tea cup. It could be over soon and markets could fall back in line with what the central planners prescribe. But somehow I doubt that this is just a blip – and interestingly, so does Mohamed El-Erian, Bill Gross’ colleague at PIMCO and the firm’s other co-chief investment officer. In an interesting article on CNN Money, he contemplated the possibility that markets were beginning to lose confidence in central bankers.
If that is indeed the case it won’t be confined to Japan but will rapidly reverberate around the world. This is a much bigger story than a modest slowing of QE in the US. Could it be the beginning of the end?
I think the central bankers may not be sleeping so well now.
Recently various commentators have been warning the Euro-zone to boost its stimulus policies in order to avoid a Japanese-style lost decade. By this they refer to the years 1991 to 2000. The average growth of real GDP in Japan during that period stood at 1.2% versus the average growth of 4.7% during 1980 to 1990. In terms of industrial production the average growth stood at 0.1% versus 4.1%.
According to many experts such as the current Fed Chairman Ben Bernanke an important factor behind this sharp weakening in Japan’s economic growth is the strong decline in the yearly rate of growth of the consumer price index (CPI). During the 1980 to 1990 the average rate of growth of the CPI stood at 2.6% against 0.8% during the 1991 to 2000 period. Note that since 1999.2 to 2000.12 the CPI rate of growth displayed persistently negative growth i.e. price deflation.
Bernanke and other commentators such as Paul Krugman have been blaming the Bank of Japan for not aggressively countering price deflation by means of massive monetary pumping. As a result, they hold, Japan fell into a prolonged period of subdued economic growth. Observe that on account of a strong increase in the Nikkei stock price index from 13,024 in January 1986 to 38,916 in December 1989 – nearly 200% increase, the BOJ had tightened its monetary pumping. The yearly rate of growth of the BOJ balance sheet fell from 15.2% in February 1989 to 9.1% by October that year. The policy interest rate was lifted from 2.5% in April 1989 to 3.75% by November that year. This triggered a fall in the Nikkei of 42% to 22,455 by November 1990 from December 1989.
Bernanke has been blaming the BOJ for not responding fast enough to the collapse in the Nikkei, which he viewed as an important factor in triggering deflation and an economic slump. It is overlooked by various commentators, including Bernanke that the foundation for the slump was set by the previous massive monetary pumping of the BOJ. The yearly rate of growth of the BOJ balance sheet jumped from minus 0.5% in November 1986 to 15.2% by February 1989. The BOJ policy interest rate fell from 4.5% in February 1986 to 2.5% by February 1987 and was kept at this level until April 1989.
On the contrary, the tighter stance by the BOJ that triggered the collapse of the Nikkei had arrested the destruction of the wealth generation process. Is it true that the BOJ didn’t do enough to prevent the economy falling into a severe economic recession thus contributing to a lost decade?
The BOJ policy interest rate had been lowered from 6% in June 1991 to 0.25% by December 2000. The yearly rate of growth of the BOJ balance sheet jumped from 6% in June 1991 to 46.6% by March 1998. So how in the world could anyone call it a non-aggressive loose monetary stance?
Contrary to Bernanke and other commentators, the lost decade in Japan occurred on account of the loose monetary stance of the BOJ. The economy fell into a slump on account of a severe destruction of the machinery of wealth generation. Instead of allowing a quick cleansing of the system the BOJ enforced massive pumping. This has prevented the elimination of the non-productive bubble activities and prolonged the economic agony.
A much greater monetary pumping as suggested by Bernanke and Krugman would have inflicted even more severe damage. In fact, on account of the aggressive monetary stance of the central bank, Japan had been in an economic slump until 2010. This means that Japan has lost not one but two decades of economic growth. Contrary to Bernanke, the key cause for that is in fact the aggressive stance of the BOJ.
We suggest that the recent policy of the BOJ to aggressively inflate the economy, which was praised by Krugman as an act of courage and wisdom, is going to further damage the wealth generation machinery and runs the risk of denying Japan yet another decade of growth.
Summary and conclusion
Recently various commentators have been warning the Euro-zone to boost its stimulus policies in order to avoid a Japanese-style lost decade. By this they refer to the years 1991 to 2000. The average growth of real GDP in Japan during that period stood at 1.2% against an average growth of 4.7% during 1980 to 1990.
Most experts, including Fed Chairman Ben Bernanke, have been blaming subdued economic growth on the Bank of Japan’s (BOJ) failure to aggressively counter price deflation.
Our analysis shows that the key factor behind Japan’s subdued growth is actually the loose monetary policies of the BOJ. These policies have severely damaged Japan’s wealth generation process.
We suggest that the recent policy of the BOJ to aggressively counter price deflation is going to further damage Japan’s economy and run the risk of denying Japan another decade of growth.
Dr Frank Shostak is a leading Austrian economist and director of Applied Austrian School Economics Ltd, which aims to assess the direction of various markets using the Austrian School methodology. AASE aims to make Austrian economics accessible to businessmen. | Contact us
5 June 13 | Tags: Japan | Category: Economics | 4 comments