Yesterday’s stop losses were triggered in the Euro Swiss LIBOR futures market. After briefly touching 100 on Tuesday (Interest rate futures are priced as 100 – the interest rate, 100 = 0%), the price surged at about 1pm yesterday to as high as 100.20 – representing an implied interbank lending rate of MINUS 0.20%.
Interest rate futures in Swiss Francs have ranged from 98.00 (implying a more normal 2% rate of interest) to yesterday’s highs over the last 2 years.
Interest rate futures are now implying that interbank lending will be below zero for 2 years, with even the June 2013 futures contract being bid above 100, meaning that banks are willing to pay an interest rate to get rid of their cash as far into the future as June 2013.
The mind boggles as to the world the bureaucrats are now moving us towards.
Another classic article, brought forward. This is a speech by James Tyler to the Adam Smith Institute Next Generation Group on 6 October 2009. This speech is also available on hedgehedge.com.
I have spent the best part of the last two decades pitting my wits against the market. It’s an unforgiving game: I’ve seen ups and downs, and many of my rivals buried under an avalanche of hubris, passion, illogical thought and unchecked emotion.
I have witnessed the sheer folly of the ERM crisis, the Asian crisis, the failure of the Gods at Long Term Capital Management and the insanity of the tech boom.
I have enjoyed the ‘NICE’ decade (Non-Inflationary Constant Expansion), and scared myself silly during the credit crisis.
I am a trader.
I risk my own money and live or die by my decisions, and face the threat of personal bankruptcy every time I switch my screens on. I get no salary – indeed I turn up at the start of the month with a large office overhead – a ‘negative’ salary. I have no fancy company pension scheme, no lucrative monopoly or franchise.
I eat what I kill.
Mistakes cost me my livelihood, so, above all, my decisions have to be rooted in practical and logical decision making.
Some have called my kind parasitic, but I would have said that I bring order, efficiency, predictability, stability and deep liquidity to a crucial process: a process that makes the whole world keep ticking.
I make money work.
I make the market in interest rate derivatives: a market born out of the neo classical revolution in finance fostered in Chicago during the 1970s. I am a child of Friedman, Fisher Black, Myron Scholes and the modern international financial system.
My analysis was steeped in the neo-classical, efficient markets paradigm.
Friedman’s ideal was working. Enlightened central bankers guided the free market with gentle nudges and short term liquidity infusions, free floating currencies gently adjusted themselves to the constant flow of new information and efficient and rational markets took all in their stride.
Credit flowed, people got wealthier, economies developed and all was well.
And then the crisis struck.
Continue reading “My Journey to Austrianism via the City”
A speech to the Policy Exchange on 31st March 2009 by Cobden Centre sponsor James Tyler. This article first appeared on hedgehedge.com but it remains as relevant today.
I want to talk about two things today;
Number 1: Free markets did NOT cause this crisis… Governments did.
Number 2: Inflation targeting has failed. Money has failed. What should we do?
Free markets did not cause this problem.
In theory, markets work by reacting to prices and direct capital towards where it will be most productively used. This is how wealth is created. Usually this works well, but markets are made up of humans, and can be fooled into overshooting by false signals.
Bubbles build up, expanding until people lose confidence. Bubbles then burst. It’s a corrective process that, relatively benignly, irons out imbalances.
The problem only comes when bubbles go on for too long, because once they get too big, the pop can be terrifying. And that’s what we’ve got now – one hell of a big bang.
False signals have caused a spectacular mal-investment in real estate and its derivatives.
But these false signals did not come from the market, but from government.
False signals came from Greenspan’s introduction of welfare for markets. Markets were taught that no matter how much risk they took, they would always be saved. 1987, 1994, 1998, 2001. Each bust bigger than the last, and disaster was only staved off with aggressive rate cuts and increased money supply.
Clearly this was not laissez faire. Just think if events had been allowed to take their course. I bet if LTCM had gone bust then a badly burned Wall Street would have learned a lesson and Lehman’s would still be around today.
In 1999 Clinton mandated that Fannie Mae and Freddie Mac reduce lending standards. The poor were encouraged into debt. This intervention triggered a race to the bottom of lending standards as commercial banks were forced to compete against the limitless pockets of Uncle Sam.
False signals came from deposit insurance. Deposit your money in a boring mutual? Why bother when you can lend it to a lump of volcanic rock in the Atlantic at 7% and be guaranteed to get your money back.
The Basle banking accords required banks to replace rock solid reserves with maths.
Government protected and regulated ratings agencies produced negligent ratings duping pension funds, who were obligated to buy high quality paper, into buying junk cleansed by untested mathematical models.
Central banks create boom-bust.
But most damaging of all was the absurdly low interest rates set between 2001 and 2004.
The resultant glut of cheap money fueled an unsustainable boom encouraging more mortgages to be taken out, and pushing property prices ever higher.
The market responded by pushing scarce economic capital towards highly speculative property development.
As prices rose people remortgaged, and borrowed to consume more. This unchecked process tended to be destructive, as scarce economic capital flowed out of our economy and headed to those economies efficiently producing consumer goods, such as China. Rampant asset inflation clouded our ability to see this depletion process in action.
Everyone had a great time whilst the party lasted, not least Governments who were incentivised to let it run, blinded by ever larger tax revenues.
But all parties come to an end, and central banks had to prick the bubble eventually. Interest rates went too high, and sub prime collapsed, and then all property prices plummeted. Trillions of dollars were ripped out of the financial system, and the credit crunch began.
It’s happened before.
But, despite its complexity, there was nothing new or unpredictable about this process. All the great busts of the 20th century were preceded by a Government sanctioned fiat currency booms.
In the 1920’s, the Fed pursued a ‘constant dollar’ policy. This was the era of the innovation, Model T Fords, radios and rapid technological advancement.
Things should have got cheaper for millions of people, but money supply was boosted to try and keep prices constant. All that extra money flowed into the stock market, pushing prices to crazy levels, and we all know how that ended.
In the modern day, targeting price changes has been an utter disaster for us too.
It let the Bank of England pretend they were doing their job, when money supply was growing at a double digit rate. It let the authorities relax whilst an economy threatening credit bubble was building up.
And it gave Gordon Brown the leeway to convince people that boom and bust was over.
Things should have got cheaper.
Inflation targeting made no allowance for globalisation, the rise of India and China, and the benign falls in general prices that should have been triggered. Think about it; if all those cheap goods were to become available, consumer prices should fall. We would have had greater purchasing power, and become wealthier for it.
But, the Bank of England was aiming at a symmetrical plus 2% target. Falling prices in some goods necessitated stimulating rises in others. They unleashed an avalanche of under priced debt and we had our own crazy asset boom.
Inflation targeting was a myopic policy.
Governments make terrible farmers.
When a central bank sets interest rates, they set the price of credit. Inevitably they create distortions.
Consider this; Governments cannot set food prices without causing a glut -or- painful shortages. Now, food is a pretty simple commodity, yet we all understand that central planners simply cannot gather enough information to set the price accurately.
It has to be left to the spontaneous interaction of thousands of buyers and sellers to set the price.
So, why do we think that enlightened bureaucrats can put an exact price on something as vital, yet complicated, as credit?
In a nutshell, if I can’t tell how much my wife will spend on Bond Street this weekend, how can they?
Let’s wake up from this fantasy.
There is a better way.
What’s the cure? Let the invisible hand to do its time honoured job. Leave interest rates to be set by the millions of suppliers and users of capital.
Get the central planners out of the way.
It’s the way it used to happen. The period of fastest economic growth the world has seen was America between the civil war and the end of the 19th century. Money was free and private and the Fed did not exist.
So, how do we get back to freedom in money? Fredrich Hayek – the great Austrian economist – did the best thinking on this. What he proposed was that private firms should be allowed to produce their own currencies, which would then be free to compete against each other. People would only hold currency that maintained its value, firms that over-issued would go bust Producers of ‘sound’ money would prosper.
History gives us plenty of successful examples of private money working well, 18th Century Scotland had competing banks, all with their own bank notes. People weren’t confused. It worked. There are many other examples.
In the modern age, technology makes the prospect of monetary competition even more tantalising. Mobile phones, oyster cards, smart tags, embedded chips, wireless networks. The internet. Prices could flash up in the shopper’s preferred currency.
Here’s an idea of how to kick the process off;
Tesco’s want to get into banking. Why not currencies as well? Tesco would print one million pieces of paper. Let’s call them Tesco pounds. It would be redeemable at any time for £10 or $15. They would then be auctioned, and the price of a Tesco set.
Anyone who owns a Tesco has a hedge against either the £ OR $ devaluing therefore the Tesco has an additional intrinsic value. Maybe they’ll auction at £12.
Tesco would specify a shopping basket of goods that cost £60. It would promise that 5 Tesco Pounds would always buy that weekly shop. The firm would use its assets to adjust the supply of Tesco Pounds so that they kept this stable value.
They would need to otherwise their shelves would be cleaned out!
As central banks inflated the £ and $ away over time, the convertibility into these currencies would matter less. We would be left with a hard currency that meant something.
There would be other competitors and a real choice about which money to hold your wealth in.
McDonalds has a better credit rating than Her Majesties Government, so maybe people would be happy to hold Big Mac tokens? I don’t know – it will be a free choice.
Currencies would sink or swim depending on how well they performed. What’s more, firms issuing the currencies would come up with different ways of maintaining their value. Some would offer Gold. Manufacturers may use notes backed up by steel, copper and oil.
Let’s see what a free market chooses. Somebody might have a brainwave and come up with an idea that nobody has thought of.
That is what free markets are best at.
I can guess the reactions that my proposal might inspire in some. How would the man on the street cope? Well, nobody would outlaw the Government’s money, and people could carry on as before. Through the operation of the market, we would find out what worked best . Step-by step, the economy would be transformed and standards driven up.
In economics, spontaneous orders are always so much more rational and stable than planned ones. Always.
This is not a crisis caused by free markets. A free and unregulated market in money has not existed for over a century.
This is a Government crisis. A crisis over the monopoly of money.
Inflation targeting seemed so persuasive…. but it was a false God, and we deserve better. Stability and sound money can only come if we put the money supply back where it belongs…
Under the control of the free market.
Another classic article from James Tyler, brought forward
Trader: One whose business is trade or commerce.
Trade and commerce is the lifeblood of wealth creation. Without specialisation and exchange, we would all starve. You have oranges, I have apples. Individually we are bored, together we have a fruit salad.
For specialisation, exchange and commerce to work its magic, firstly we need some common ground: a market. Now, mention that word to a Socialist, and he starts to froth and foam at the mouth. The evil of markets, how the market forces this and exploits that, blah blah.
Unfortunately, they are confused. You see a market is just a bit of space, physical or virtual, where people who want to buy meet those willing to sell. That’s it. It has no power of its own. No influence. No horns and a pointy tail.
However, badly aimed as their invective is, they do have a fair grievance lurking in those passionately beating breasts. What they are trying to say is that they object to those who have power in a market. Who wields the power in a market, and where does it come from? That is a fair question to ask.
I contend that power always comes, ultimately, from Government. They hold the monopoly on power, they set the rules, and their arbitrary decisions can mean life or death for any businessman taking a risk. They get the keys to the gun cabinet.
Markets and traders
Only loons attack commerce between good old wholesome types looking to exchange the hard earned fruits of their labour for other stuff they need: I exchange my apples for your oranges.
Unless, that is, you want pears. The free interaction of people that is the market decided on a clever mechanism to get around this problem. It created an intermediate commodity called money.
Money is just a commodity like any other. The free market chose something that was durable, portable, respected, and consistent. The free market originally chose gold and silver as money, and gold remained money until governments came along and nationalised then destroyed it. Money now is a fraud – the greater fool theory of acceptance only because somebody else will too.
The creation of money was a fantastic innovation – a neat solution to the problem of the double coincidence of wants… or rather what to do when there wasn’t a coincidence.
But what happens if an orange farmer wants to sell next year’s crop now? Maybe there is a great demand for oranges and the farmer has cultivated trees to meet the demand, but does not want to take the risk of a craze for plums depressing the demand for oranges. A consumer of oranges may only want to buy what he can pick up and select. A grocer may not want to tie up his cash in something so far off into the future.
What is needed is someone in the middle. Someone willing to guarantee a price for those oranges now, take them in the future and then sell them on when they are needed. This is where the speculator steps in and provides a vital service.
Ahh… the evil speculator, now there is a ripe target!
How can somebody who produces nothing, does not employ physical labour, and does not reorganise the factors of production, be in any way productive in society? Off with their heads!
Speculator: one who speculates on abstruse or uncertain matters
The key is uncertainty. The future is not known; if it was, then the central planners might stand a better chance. But the future peculiarities of individual desires and wants can never be known, so there are always highly uncertain outcomes inherent in planning for the future. The world is too complicated to simplify into maths or bureaucratic diktats. The risks are too great and the mistakes too expensive. What we need is a mechanism to attempt to put a price on future outcomes. We need to “crowd-source” the answer to the problem of resource allocation. And, that’s what speculation is…
I risk my own shirt to take on risks that others do not want. I’m proud to say I speculate. I speculate that I will be able to find another buyer for those risks at a future point in time, and then I charge a fee for my services.
Some say that this is making money from nothing, but I say I provide a service to the world in smoothing out the jagged pointy edges. If things go wrong, I will have to pay the price personally.
The act of speculation is important in the signals it sends out. If prices rise, it signals a shortage which stimulates extra production to satiate demand. Or if the speculator successfully sells short some shares, the falling price will send out a signal that not all is well with that company.
Let me quickly clear a couple of things up …
Markets are not efficient
This is a stupid, indefensible idea peddled by neo-classicist eggheads. Information is often wrong and therefore people err. Mistakes are made, but I contend that the mistakes made by crowds are much smaller than when Government gets its grubby hands on a ‘problem’.
Markets work in waves and ripples and patterns, not aggregates, averages and efficiencies
Early adopters get rewarded the most; late arrivers are penalised. The crowd sometimes gets carried away, and prices rise too much or fall in an unwarranted way, but by and large, when not unduly influenced by power, markets are a remarkably efficient way of making a myriad mind-numbing decisions that all hang together. Markets are smart in the way a regulator can never be.
Secondly, I want to sing the praises of those great unsung heroes of stock markets: the short sellers.
Selling short is the process of selling something you do not own, in order to profit from a fall in prices, then buying it back at a lower price.
Short selling is a dangerous game. You are hated by all and sundry. Governments, regulators, corporate bosses, and fat cats. Everyone, it seems. You are always at risk of being targeted for a ‘short squeeze’. But short selling is vital for two reasons:
1) Buyers need a seller to buy from.
If you want to buy some shares – who do you think it is that will sell them to you?
It’s not usually an investment fund, or a pensioner, or your mate. It’s the ‘market’, and it is more than likely that the person you bought them from will not own them, but will scrabble around for the rest of the day trying to find them a penny cheaper. Can you be bothered to do that?
The stupidity of banning short selling is that it stops the market working – meaning that movements are likely to be bigger, and the falls greater.
2) Short sellers are the policemen of the markets – a much better (and more fearsome) regulator than the FSA.
Without short sellers, Enron and WorldCom would have got away with their fraud for a lot longer. It is a tragedy that the short sellers of banks were not bigger and better armed during the run up to the sub-prime crisis.
Don’t get me wrong, short sellers were there, playing their lonely game, but they were just too small in face of the great money/banking juggernaut carelessly careening away. Stronger short selling might have seen off the sub-prime fiasco earlier and with less pain.
As a society, we should desperately be encouraging short sellers in situations like this. Big business needs to respect the short seller – it keeps them honest. When prices are rising in a rampant fashion, usually no good comes of this. This is when we need the short seller to tame the wild beast.
Speculators do a much better job of sifting through the morass of conflicting signals to fish out the price for the best allocation of resources in a way that Sir Humphrey, sitting in an ivory tower in Whitehall, could only dream about.
So, traders and speculators are vital for a productive and fully-functioning capitalist economy. In a pure and free economy, they are a force for efficiency and part of the crowd-sourced resource allocation system.
But unfortunately, we do not have free markets
The sub-prime fiasco has shown us that markets, especially financial markets, are anything but pure. Markets are distorted by power, and it’s important to turn your swivel gun onto the source of that power….
The one thing you should always know about busts is that you can’t stop the pain at that point: it’s too late, the damage has already been done. The boom may have felt good at the time, but those tequila slammers at 2am always seem like fun. Remember the feeling in the morning. Trying to alleviate the hangover by more of the same is the action of an alcoholic. It’s the boom when assets are wildly misallocated, and that’s where we should focus.
The sub-prime crisis started with government, was promoted by government agencies, and was taken to the dizzying heights of stupidity by a banking system fuelled with masses of cheap money, produced by central banks that panicked after the previous cheap money bubble went pop in 2001.
The bankers perceived an inexhaustible supply of cash that could be lent at a profit to people who had no chance of paying back. The Mexican strawberry picker given a $750,000 loan to buy a house he could never afford to repay. A cleaner running a buy-to-let portfolio of 4 houses, with zero down payment.
What’s the problem with banks, after all, it’s a free world?
Banks are not run by kindly old bespectacled men, carefully lending money to young families to give them their first break. Remember It’s a Wonderful Life with Jimmy Stewart – the friendly banker looking after good ol’ townsfolk? Scrub it from your mind.
Banks are vast hedge funds, with vast trading floors of speculators, all doing “God’s” work, as some idiot once said.
One UK clearing bank has been described as a huge smart hedge fund, with a mediocre provincial bank bolted onto its underside. That’s probably true for all of them.
A few starters on banks:
1) They are licensed by the government. I cannot start up a bank – neither can you, unless you go through the various hoops, fires, and barriers erected in front of you. You need mountains of capital. They make it difficult to join their club.
2) They operate under a specially loosened set of accounting rules.
Normally, companies are required by accounting rules and law to make sure they provide for their liabilities as they fall due. If you order a load of gear on credit, you have to show that you have the ability to pay for it – and pretty rapidly. Companies are expected to make their creditors ‘whole’
Look at the accounts of Vodafone and in their balance sheet they have to provide for ‘current liabilities’ and ‘long term liabilities’, but not so for a bank. Banks get away with a broad ‘liabilities’ section, with no attempt at sorting near term risks from long terms assets. It doesn’t matter whether they owe money tomorrow and are due to cover it in 5 years time.
3) Banks thrive on red tape, loopholes, fuzzy wording and obfuscation
For instance, 75% of people in this country believe that when they place their hard-earned money in a current account, it remains their money. It most emphatically is not. You hand your money over, and you get a promise. Well, I say promise, but the bank goes to great lengths to hide this fact. You are given a statement, which shows your money proudly sitting there, waiting for you – all safe and sound.
Except it’s not.
It is being lent out to Dubai World! Or passed onto the trading floor, and being pushed into Alphabetti Spaghetti Derivative Hooplas, funnelled into their massive casino operation.
Even though you might spend it tomorrow, the bank will not have your money. If you want it, they have to get it from somebody else’s account, or go onto the money markets and borrow it.
4) A bank is an operation designed to make profits from money that is not their own.
When you put your Tesco’s money into a bank, you are investing in a hedge fund, except you don’t get any of the profits. If it all goes wrong, as it did in 2008, then the taxpayer pays for all the losses.
Even in the good times, the taxpayer insures deposits (explicitly or implicitly), leaving the banks free to gamble away. Does this seem like free market capitalism to you?
What is the problem with this, after all, it’s a free world?
Well, it’s not. As I said before, banks operate with privilege and monopoly rights, with taxpayer backing. And we can add a final potion into the mix: incentive and liability
The sub-prime crisis cost Wall Street and the City trillions, or rather it is costing taxpayers that much. If I lose money, I remortgage my house; otherwise I don’t come back.
When Goldman Sachs put all its eggs in the AIG basket, they should have received a bloody nose – at the very least. Yet uncle Sam paid them out 100c on the $ and Goldman scored a slam dunk. God’s work, eh? A miracle indeed.
A trader called Howie Huber recorded the single biggest loss ever at a bank. He cost Morgan Stanley over 10 billion dollars, but he got to keep the 24 million dollar bonus he earned the year before.
Dick Fuld at Lehmans faced some devastatingly hard questions from some horrible congressmen, but retired a very rich man.
It was the taxpayer who paid the price. Private profits and socialised losses – emphatically NOT what I’d call free market competition.
Now I don’t mean that we should round these guys up and shoot them, or even take their bonuses back – they signed contracts, and we respect the rule of law, and contracts. It’s the basis of our freedom and we risk tyranny if we selectively choose to violate these rights.
We have to recognise that bank traders get a free option. You can bet it all on red or black: win, you get a bonus. Lose, you may lose your job – but then probably use your ‘reputation’ to walk into another one.
The system is wrong, and something must be done about it.
In terms of dealing with the crisis we have to understand that damage is done before we are aware of it. In the sub-prime crisis, it was done in those happy days of 110% mortgages, up front discounted rates, and more freshly printed money than you know what to do with. We were killing our economy with cheap money love.
When gravity asserted itself, and the inevitable bust came we faced a simple choice: take the pain, or hide it.
In 1982, 100 Keynesian economists wrote a letter to the times saying that the government’s economic policies were suicide. It’s a bit of a coincidence, then, that that was the exact moment the real economy started to grow. Time and again, history shows us that if we take our medicine early, we get through the illness quicker.
Or we could take the Japanese/Keynesian approach, and hide it with fiscal aggregate kabalah nonsense. And lose twenty years in the process
But banks.. what should we do with them?
1. Firstly, banks should not speculate with your beer money – unless you understand this, and you explicitly sign it off.
2. Banks should be audited as strictly and as thoroughly as normal companies are – no favours.
3. Banks should legally have to provide for liabilities as they fall due – as every other company should.
4. Banks should offer accounts that are 100% reserved. That is where your money is kept safe, not used to speculate – and it remains your property.
5. Speculation should be undertaken by hedge funds and specialist trading groups, not by deposit-taking institutions, or by the likes of Barclays, that can borrow money from the Bank of England at 0.5% and walk over to the craps table.
6. Anybody, or company, that offers fiduciary advice should face 100% liability in case it goes wrong.
And most importantly,
7. Any person paid more than a certain amount by a bank, should be liable when things go wrong.
The contract that Dick Fuld signed should have meant he lost his house when he crashed Lehman’s. Howie Huber should now be serving Big Macs. And Lloyd Blankfein should be a little more circumspect when talking rubbish about doing God’s work.
God is watching you mate… be careful.
Forty years ago today, Britain moved to decimal currency. A 1971 penny was worth the equivalent of today’s 10p. In recognition of this dramatic debasement, and its devastating effects, we are bringing forward this classic article, originally published in December 2009.
Mr Smith works hard, plans carefully, and saves what he can, putting his money into a building society. He pays his credit card bills off each month, and tries to overpay his mortgage when he can.
Mr Smith got a 3% pay rise last year – inflation was only 2% – so he felt good about that. But… he doesn’t feel any wealthier.
Year after year, the government had said that the economy was growing strongly, but still, things seemed harder for his family and him. Train ticket prices up again. Heating bills rocketed when the price of oil went up, but never seemed to come down. He swears a loaf of bread and a pint of milk were much cheaper in years gone by.
When he changes his cash for Euros, he realises that his holiday in France is now unbearably expensive. His tax rates didn’t go up, but still, after all his bills were paid, he seemed to have less and less spare cash than he remembers a few years ago.
There are Mr Smiths everywhere. Careful folk, who plan, save for a rainy day and have a sense of personal responsibility.
Smith is the target.
It is Mr Smith who is going to pay for the banking crisis.
His saved wealth will pay the national debt.
His prudence will bail out Gordon Brown’s profligacy.
His forgone holiday will pay the banker’s bonuses.
His careful spending will pay for the vast number of quangos.
His financial planning will bail out the failed NHS computer project, over-budget military programs and ID cards.
His sense of responsibility will end up funding the destruction meted out in Iraq and Afghanistan.
It won’t be the politicians or the bankers who pay for global warming – he will.
He knows he pays tax… but what is hard for him to comprehend is that there is another pernicious process draining his wealth and subverting his hard work towards paying for the misjudgement of others. Whether he likes it or not, he naively pays for the decisions made by the political class.
He has no choice. No option. He was never asked to vote for it. And for the most part, the act of theft is so subtle he doesn’t even know it is happening.
Why does he feel poorer?
Why is it that Mr Smith seemed to miss the ‘boom’, yet is hurting more in the bust? Why doesn’t life get easier for him? What is going on?
As technology produces things more cheaply, Mr Smith should have been able to reap the rewards – except that things don’t get cheaper for him. Society cheats him when the government opens the spigot of new money, washing this value away as the torrent of new money chases prices higher beyond his reach.
The winners are always those close to the gusher – the banks, financiers and politicians. These are the ones who get to spend the new money first, thus chase prices up before Mr Smith gets any sniff of what is happening.
To save or to invest?
Think about your personal circumstances. Every time your payslip comes in, you have a choice of how much to spend and how much to save. Every rational person knows that there is a balance to be struck between current enjoyment (consumption) and future enjoyment (savings – or deferred consumption).
This choice is exactly the same for society as a whole. As a country, we must decide how much to consume, and how much to defer consumption in order to allow our children and us to enjoy things in the future.
The choice for us all is simple. Defer consumption and invest for the future, or consume and enjoy now.
What is the process by which we save for the future? There are two ways.
- Voluntary saving. If society needs to invest for the future, but people prefer to consume, then the savings rate – the profits paid on investments and/or the interest rate paid on deposits, rises until people choose to defer consumption and invest.
- Forced saving. Government policy forces a decrease of the purchasing power of money via inflation of the money supply. The net effect is a transference of wealth from savers and fixed income groups towards net borrowers (itself included). It also creates an artificial pool of liquidity into which the government can sell its IOUs.
The evil of Forced Saving
The natural state of affairs in a free market, with a more consistent supply of money, is that general prices fall as technology advances. The prudent are rewarded, and borrowers have to carefully evaluate and moderate their flights of fancy, only investing borrowed funds carefully in sound projects.
When the value of money declines, savers find that their money buys less, whilst borrowers are happy to find that they can repay their debts with money of a decreased value. It’s like borrowing five books from the library and finding that you are only required to give four back!
By setting a target for rising prices and then pulling levers to increase the supply of money in the economy to achieve it, the government prevents the natural response of general prices to competition, increased efficiency and innovation: they stop prices from falling.
Entrepreneurs, innovators, inventors and new businesses exist because they believe that they can satisfy society’s wants better than they have been served before. They have ideas, innovations and take risks in order to provide goods that are cheaper than they otherwise would be. Businesses operating in a competitive environment always seek to reduce costs, be that one step more efficient and produce a cheaper or better widget. As group of people, entrepreneurs bring efficiency and innovation, and they make stuff cheaper.
The benefit to Mr Smith should be that his income goes further. As time progresses, technological innovation should mean he can buy more with the same cash. But that’s not what happens, as any pensioner knows. Saved money buys far less now than it did at the time it was saved.
Governments achieve rising prices by encouraging the supply of new money. This new money comes from the central bank via its control of the banking system. The first users of this new money are invariably politicians, finance capitalism and big business. These guys get to use the newly minted money first, and thus spend it first. This process bids up prices, leaving everyone else chasing behind, and poor old Mr Smith last in the queue.
What an evil system it is then, when government can control money in such a way as to give it a first user advantage that penalises all those in the general population whose wealth is being rapidly diluted. A process that systematically violates and loots pensions, savings, fixed incomes and the actions of prudent, and rewards the profligate, the speculative borrowers and above all, rewards the biggest borrower of all: Government.
Let’s be clear. The current system is a process that diverts the benefits of innovation and technological advancement that should accrue to the general population, and thrusts it towards the desired spending of the well connected and the political class.
We need to stop this continual violation of the little man. Mr Smith has to start realising what is happening to him.
That’s why I’m proud to support the efforts of the Cobden Centre.
Bob Diamond gave a spirited defence of himself and his industry yesterday at a Parliamentary select committee hearing. Surely it is hard to disagree with him too much?
Barclays did not take a bailout from the tax payer, instead securing funds via the free market. Diamond acted audaciously in catching some of the dismembered limbs of Lehman’s that others were too scared to go for, and generally has been a pretty effective manager of his business. That’s it then.
Whoa, hold on. That is most certainly not it.
Barclays may not have taken direct tax payer investment, but it has supped (gorged, really) at the Bank of England’s special liquidity scheme. Without this pork geyser of state aid, Barclays would surely have gone to the wall. This was not some magical money of no consequence that was whistled up out of thin air, it was the taxpayer taking on the very worst risks that they had on their books, in return for freshly printed (electronic) cash, debasing the rest of us in the process.
Secondly, Barclays took a bet, not that bits of Lehman’s were being thrown away at rock bottom prices, but that governments would step in and bail out the banking industry as a whole, explicitly as well as implicitly, thus making those bits of Lehman’s worth something. Without the trillions of US taxpayer dollars thrown at Wall Street, those bits would surely be worthless.
Thirdly, the banking industry, Barclays included, have benefited from a hidden bailout. Quantitative easing: a process where the central bank buys assets directly from the banks (often the same bonds the banks bought from the treasury at a lower price some days before), to the engineered ‘positive yield curve’ where banks can buy longer terms assets earning high rates of interest, and then fund them at absurdly low rates at the funding windows of the central bank. The money-making opportunities given to the banks by the state, in the name of ‘balance sheet rebuilding’, are truly obscene.
Can any individual or small business benefit from interest rates at close to zero? Is any normal person able to borrow at those levels? No, of course not, we all know we’re paying many points over the base rate for our overdrafts, credit cards, mortgages and so on. Barclays and others are now raking in mountains from borrowing at close to zero and lending it out at 4, 5, 10 and 20%. And the market is rigged to allow this to happen. Are your hard-earned savings paying much? No, but Barclays takes your money, and uses it to fund its own smart trade ideas – the profits of which it, and Mr Diamond, get to keep.
So, Mr Diamond, I can respect your talents, your chutzpah, acumen and entrepreneurial flair, but please, go and do it in the real world, with a real business, where your talents would, via enlightened self interest and the invisible hand, benefit society enormously, instead of feeding the giant vampire squid attached to all our faces.
Money has a specific role in economic affairs – the facilitation of specialisation, trade and exchange.
Sure, money has a fantastic set of ancillary benefits, storing wealth, a common unit of account, measuring efficiency and success (or failure), deferring payments and so on, but the historical evolution of money has gone hand in hand with mankind dividing up the complexities of life, specialising in what they are good at and then freely exchanging the fruits of enhanced production. This process has made nearly all of us more comfortable in life than our forebears.
Yet the power of money has proved irresistible to policy makers the world over. Economic difficulties? Cut rates. Terms of trade harsh? Ease monetary conditions to change them. Government struggling to raise funds freely? Print money to buy the bonds.
Gradually authorities subverted and then nationalised money. The trend has been relentless.
Then, along came the Euro. Steeped in the ‘hard money’ tradition of the Bundesbank and the Deutschemark, the European Central Bank was created. The link between a single country and its currency was broken. Remember, the classic liberal standard was that money was Gold, and was not linked to a particular country or economy.
Money was divorced from political control.
The nuclear trigger of devaluation was removed.
Devaluation is an act of economic war – defraud your creditors, shunt your problems onto the unlucky devalue-ee, and create mayhem in your market pricing process by introducing inflation. Much better to honestly, and openly, default, then move on.
In a global crisis, not every economy can get rid of its problems by devaluing. Much as each country couldn’t protect its native industries by unilaterally raising tariffs during the thirties.
Time and again, the ECB was criticised for its hawkish stance, whilst the BoE and Fed printed away to solve our worries. Bankers hated ‘Dim Wim’ Duisenburg due to his ‘luddite’ attitude towards risk and fiscal responsibility and reluctance to respond to economic events. Oh how we now wish all our central bankers were a little less hip with the times…..
Now, don’t get me wrong. This was still a bureaucrat controlled affair, prone to forecasting and estimation errors. It is also a political creation, and what political will puts in place, it can change and destroy. It is not a structure or solution that any of us Cobdenites could advocate.
But, consider Europe’s problems. As ever, they are a failing of government (and its vassal bankers) not the market. What the ECB constantly sought to preach was the need for individual states to be disciplined in their financial affairs. The strong inference was that the ECB would not be there to bail out the irresponsible.
As the European sovereign debt market stumbles forward into its next crisis, the ECB looks set to crumble to political pressure and massively monetise the debts of the profligate, corrupt and incontinent states of Europe. Tragic as this is, the ECB held out a lot longer than its besieged brethren.
The failure of the Euro is a failure of bankers, regulators and politicians, not of the particular choice of the means of exchange that is used by people to do business.
If banks had been forced to survive without special favour, if governments had been forced to live within their means, and crucially, if the tax payers had not been forced to pick up the tab for corrupt bankers (and done this in 2008), we would be growing strongly by now, and the future would look a lot rosier.
And the Euro would be admired, respected and wanted the world over.
Two points to ponder:
Firstly, when the Euro exchange rates were locked, the common consensus was that Germany paid the price with an over valued Deutschemark locking them in at an uncompetitive rate. The PIIGS rejoiced at their advantageous rates. Germany went through tough years, and they had to become ruthlessly efficient to prosper. That they did: who is laughing now?
Secondly, Euro sceptics hail the UK experience of the ERM. We were killed by being in it, and flourished when we allowed the currency to float down after we left it. Sure, we benefited from the exit, but, applying an Austrian analysis to the situation, didn’t the discipline of the ERM membership force British industry to cut waste, reorganise and become hyper-efficient, so that when conditions eased, we could reap the benefits without unleashing yet another inflationary boom, destined to end in despair? A solid boom that lasted for nearly an unprecedented (for us) two decades?
News flash from the Commissariat of Monetary, Mystical and Magical Affairs: A glorious bountiful future is upon us! Science has conclusively proven that savings are anti-progressive. Science has prevailed. You may now enjoy the bounty of our success and consume at will!
Comrades, it is now thirteen years since the liberation of banking from the evil yoke of the hated Westminster Illetrati, and stupefying progress has been made. Right from the outset the new owners of the banking system, the MPC (Magical Pronouncements Committee) has steered the glorious (bank) workers towards an unstoppable era of perpetual prosperity.
Our perpetual energy anti-graviton money flotation device (known as the economic model) has once and for all ended the inefficient distribution of money, and apart from the odd hiccup, a never ending prosperity has been achieved. This fact has been scientifically proven by use of the officially approved scientific papers produced by our colleagues in the (un)free banking world (known as annual profit and loss statements).
It is with this wonderful news pulsating through our veins and the joy in our hearts, that we must now announce some final tweaks to the scientific formula that will save us all from hard work, irresponsibly ‘saving’ (ha!) for a so called ‘rainy day’ (see pronouncement 737845, circa May 2007, where rainy days were banished forever).
My fellow consumers, we have secured the very latest Bernankopters, loaded with magic money token sprays, but you too must do your bit to further expand our success.
In order to assure our glorious future, we must now spend it! Fear not dear travellers, this is the era of black-is-white. Night has been turned into day.
It has come to the attention of Commissar Charles Bean that anti-dirigiste elements are spreading a heresy that we have somehow ‘over consumed’, that the glittering successes were a sham and that the lack of savings should be compensated by the voodoo of ‘thrift’.
Comrade Bean urges you to ignore these siren calls.
It is pronounced that we must all suppress our fears and consume for the future!
An entertaining article, choc-a-bloc with Monetarist whitewash, in The Telegraph today.
Apparently Jean Claude Trichet is “inflicting a triple shock of fiscal, monetary and currency tightening on a broken economy”.
Well, at least I agree with the last part. Europe’s economy is well and truly broken, thanks to a decade of loose monetary policy, low private savings, bankster socialism and the fiscal incontinence of our various Kings of Europe, but is Ambrose saying that the cure should be more of the same?
A “deflationary vortex” is what is awaiting us around the corner. Well, I agree things are bad. Monumentally bad. The plane is out of fuel (they never put enough in), and we are lurching downwards – and this is going to hurt. We are facing massive credit deflation in the private sector.
“Spiraling public sector debt precludes further Keynesian spending, so this must come from central bank stimulus.”
Uh, what? Oh please.
Let’s take a step back from all of this aggregate nonsense, and think, in clear, incisive, terms what is happening.
1. Central banks were in control of setting interest rates
2. Given low headline CPI inflation (which is a very problematic measure), policy tended to be looser than the free market would have been, and interest rates were set artificially low. (No central banker would ever keep rates a little too high – that would have risked a deflation shurely, hic, pass the punch bowl).
3. As the price of credit was set artificially low, excess credit was demanded (that bit of ‘A’ level economics, supply and demand curves, sort of work), and was happily met by the banks (thanks be to Mr. Taxpayer for all that free insurance of deposits allowing them to be lent out again and again and again).
4. People bought stuff with that credit, especially houses. Remember house price rises in 2005 and 2006 – did it seem silly or not?
5. Higher asset prices supported more credit creation by our taxpayer guaranteed banksters, which fed into higher asset prices etc
6. Something happened, depositors wanted their money back, and the spiral went into reverse
Excess private sector credit creation was the problem. The market is now trying to correct this mistake, and banks are being forced to call in credit lines that should have never been given out in the first place. Heartless some will say, but it cannot be helped. The damage was done during the period of credit creation and the resultant boom, the best thing to do, now, is to trust the free interaction of people to swiftly reallocate wasted resources from misuse towards productive use. The statist alternative is to try to mask and hide the pain, as the Japanese did in the 90’s. Look where it got them.
Now think a little about what the usually-admirably-free-market Ambrose Evans-Pritchard implies.
“Far from taking steps to offset Club Med austerity [err ‘Austerity? Shouldn’t that read ‘sanity’?] it is winding down its €50bn purchase of government bonds”
The implication here is that we should purchase more of those government bonds, all with newly-created money tokens.
Am I the only one to be horrified at the spectacle of the emperor’s nakedness here? Think about what AEP implies should be done:
1. Private sector credit is being called in, so;
2. The central bank, the guys who got it wrong in the first place, are the guys to deal with it, sooo;
3. The destruction of private sector credit (i.e. banks calling in loans to you and me) should be offset, soooo;
4. They create public sector credit via QE, soooooooo;
5. Public sector credit allows government to do more things than it should not have been doing in the first place
This credit for the purchase of government bonds does not appear out of thin air. It is funded by devaluing all of the privately held money in existence. It does nothing to sort the structural problem of business and consumer loans being called in.
The net result, after all of this, is a smaller private sector and a bigger state (unless, that is, you surrender yourself to a belief in some kind of magical process in the middle, called Monetarism or Keynesianism).
Mr. Evans-Pritchard, why are you so ardently, and happily, proposing a massive expansion of the state?
Where’s the market reaction? Yawns the prophet of Princeton, Paul Krugman in response to the passage of Obama’s health care bill.
In totally separate and completely unrelated news on the same day, the yield of the 10 Year US Government bond rose to 2.5 basis points above the 10 year interest rate swap rate (the rate at which banks can fix their lending rates to each other). (h/t zero hedge).
Allow me to explain how Obama’s passage of trillions of dollars of liabilities onto America’s children has no link at all to the fact that US government debt now requires a higher interest rate than the equivalent rate of interest charged between all of those bankrupt banks.
Er, hold on, something doesn’t quite compute here….
The serious point here, given that uncle Sam needs to pay roughly the same rate as its banks to attract finance, is that the next crisis is likely to be a governmental one (Sovereign risk in market parlance) rather than the banking system that created the risk in the first place.
The banking system is now a fully fledged arm of the state.