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Today, the Telegraph reports, UK house price growth ‘approaching madness’:
The speed UK property prices are rising at is “approaching madness”, analysts have warned, after data showed house prices jumped 2.4pc in February, the biggest monthly increase in five years.
The rise, revealed in the latest Halifax House Price Index, outstripped analysts’ expectations of a 0.7pc rise, renewing fears of a house price bubble.
House prices advanced 7.9pc on an year-on-year basis, the figures showed, taking the average price across the UK to £179,872 and marking the strongest annual uplift since October 2007.
The Chancellor’s policies of “monetary activism” and “credit easing” including Funding for Lending and Help to Buy have, on their own terms, succeeded. According to Kaleidic Economics, the Austrian measure of the money supply is now expanding by over 12% year on year:
Click for Kaleidic’s data
Nothing has been learned since Hayek wrote Monetary Theory and the Trade Cycle. His preface could have been written today:
It is a curious fact that the general disinclination to explain the past boom by monetary factors has been quickly replaced by an even greater readiness to hold the present working of our monetary organization exclusively responsible for our present plight. And the same stabilizers who believed that nothing was wrong with the boom and that it might last indefinitely because prices did not rise, now believe that everything could be set right again if only we would use the weapons of monetary policy to prevent prices from falling.The same superficial view,which sees no other harmful effect of a credit expansion but the rise of the price level, now believes that our only difficulty is a fall in the price level, caused by credit contraction.
… There is no reason to assume that the crisis was started by a deliberate deflationary action on the part of the monetary authorities, or that the deflation itself is anything but a secondary phenomenon, a process induced by the maladjustments of industry left over from the boom. If, however, the deflation is not a cause but an effect of the unprofitableness of industry, then it is surely vain to hope that by reversing the deflationary process, we can regain lasting prosperity. Far from following a deflationary policy, central banks, particularly in the United States, have been making earlier and more far-reaching efforts than have ever been undertaken before to combat the depression by a policy of credit expansion—with the result that the depression has lasted longer and has become more severe than any preceding one. What we need is a readjustment of those elements in the structure of production and of prices that existed before the deflation began and which then made it unprofitable for industry to borrow. But, instead of furthering the inevitable liquidation of the maladjustments brought about by the boom during the last three years, all conceivable means have been used to prevent that readjustment from taking place; and one of these means, which has been repeatedly tried though without success, from the earliest to the most recent stages of depression, has been this deliberate policy of credit expansion.
On its own terms, systematic intervention in the market for credit has succeeded: it has restarted the Domesday machine which delivered us into this mess. Those of us who have studied Mises, Hayek and the other Austrian-School masters will know that our present economic system remains built on sand.
The Bank of England
This article originally appeared in The Telegraph on 5 March 2014. It is reproduced by permission of the author.
Five years ago today, the Bank of England cut interest rates about as low as they can go: 0.5 percent. And there they have remained.
If rates have been rock bottom for five years, our central bankers have been cutting them for even longer. You need to go back almost nine years to find a time when real interest rates last rose. Almost a million mortgage holders have never known a rate rise.
And this is all a Good Thing, according to the orthodoxy in SW1. Sure, low rates might hit savers, who don’t get such good returns, but for home owners and businesses, it’s been a blessing.
Don’t just compare the winners with the losers, say the pundits. Think of the whole economy. Rates were set at rock bottom shortly after banks started to go bust. Slashing the official cost of borrowing saved the day, they say.
I disagree. Low interest rates did not save the UK economy from the financial crisis. Low interest rates helped caused the crisis – and keeping rates low means many of the chronic imbalances remain.
To see why, cast your mind back to 1997 and Gordon Brown’s decision to allow the Bank of England to set interest rates independent of any ministerial oversight.
Why did Chancellor Brown make that move? Fear that populist politicians did not have enough discipline. Desperate to curry favour with the electorate, ministers might show themselves to be mere mortals, slashing rates as an electoral bribe.
The oppostite turned out to be the case. Since independence, those supermen at the central bank set rates far lower than any minister previously dared. And the results of leaving these decisions to supposedly benign technocrats at the central bank has been pretty disastrous.
Setting interest rates low is simply a form of price fixing. Set the price of anything – bread, coffee, rental accommodation – artificially low and first you get a glut, as whatever is available gets bought up.
Then comes the shortage. With less incentive to produce more of those things, the supply dries up. So, too, with credit.
With interest rates low, there is less incentive to save. Since one persons savings mean another’s borrowing, less saving means less real credit in the system. With no real credit, along comes the candyfloss variety, conjured up by the banks – and we know what happened next. See Northern Rock…
When politicians praise low interest rates, yet lament the lack of credit, they demonstrate an extraordinary, almost pre-modern, economic illiteracy.
Too many politicians and central bankers believe cheap credit is a cause of economic success, rather than a consequence of it. We will pay a terrible price for this conceit.
Low interest rates might stimulate the economy in the short term, but not in a way that is good for long-term growth. As I show in my paper on monetary policy, cheap credit encourages over-consumption, explaining why we remain more dependent than ever on consumer- (and credit-) induced growth.
Cheap credit cannot rebalance the economy. By encouraging over-consumption, it leads to further imbalances.
Think of too much cheap credit as cholesterol, clogging up our economic arteries, laying down layer upon layer of so-called “malinvestment”.
“Saved” by low rates, an estimated one in 10 British businesses is now a zombie firm, able to service its debts, but with no chance of ever being able to pay them off.
Undead, these zombie firms can sell to their existing customer base, keeping out new competition. But what they cannot do is move into new markets or restructure and reorganise. Might this help explain Britain’s relatively poor export and productivity performance?
What was supposed to be an emergency measure to get UK plc through the financial storm, has taken on an appearance of permanence. We are addicted to cheap credit. Even a modest 1 per cent rate rise would have serious consequences for many.
Sooner or later, interest rates will have to rise. The extent to which low interest rates have merely delayed the moment of reckoning, preventing us from making the necessary readjustments, will then become painfully evident.
We are going to need a different monetary policy, perhaps rather sooner than we realise.
Röpke, International Economic Disintegration
In 1942, Wilhelm Röpke’s International Economic Disintegration was published. An international order of liberal free trade collapsed through nationalism, protectionism and monetary destruction. Many other factors were at work. The various events occupying the forefront of public attention were “only surface symptoms of a deep-set structural change affecting our economic, social, political and cultural system in its entirety”. The social sciences were in crisis and found themselves in a new situation. Monopoly and state intervention had led to the degeneration of competitive capitalism. What had gone before was unhampered trade. What came after was widespread acceptance of state intervention in business life.
Globalisation in the sense of international trade is by no means a new phenomenon: the internationalisation of business regulations is and it has consequences. On 4 December 2012, I reported a problem with the EU regulation of biocidal products which was hammering two UK businesses whose products fight legionella by ionisation. Over a year later, the problem still rattles on with special interests apparently capturing the regulatory apparatus to the detriment of smaller, more effective firms. The financial risks to our stretched hospitals are considerable.
It’s just one example of how the regulatory state fails: how it makes us poorer, discourages innovation and entrenches special interests. It takes power out of the hands of the elected and hands it to technocrats: technocrats who tend to continue down their chosen path irrespective of the futile cries of those of us who represent the victims of bad rules.
The situation is dire enough at European Union level but now here comes the Transatlantic Trade and Investment Partnership:
The Transatlantic Trade and Investment Partnership (TTIP) is a trade agreement that is presently being negotiated between the European Union and the United States.
It aims at removing trade barriers in a wide range of economic sectors to make it easier to buy and sell goods and services between the EU and the US.
On top of cutting tariffs across all sectors, the EU and the US want to tackle barriers behind the customs border – such as differences in technical regulations, standards and approval procedures. These often cost unnecessary time and money for companies who want to sell their products on both markets. For example, when a car is approved as safe in the EU, it has to undergo a new approval procedure in the US even though the safety standards are similar.
The TTIP negotiations will also look at opening both markets for services, investment, and public procurement. They could also shape global rules on trade.
Big firms such as car manufacturers tell me they love it. And why not? One set of rules is in their commercial interests. One set of officials is easier to lobby than several. It’s possible to argue enthusiastically for TTIP and state-directed trade policy, as the EU demonstrates:
But this is not free trade. This is not merely the abolition of tariffs. It is the elevation of the principle of all-encompassing networks of regulation to ever more international and less accountable levels. Woe betide the company which falls foul of a rule agreed by the EU and the US Federal Government: your representatives will have no vote and their correspondence in protest will be just so much chaff in the email storm.
I’m no scholar of Röpke but it seems at least one thing about his analysis was correct: competitive capitalism degenerated into a dangerous interventionism and a crisis of the social sciences which has brought us to our current predicament. Once again, the events which occupy the public consciousness are mere symptoms of much deeper issues: the belief that political power on an ever greater scale is required to shape our lives.
At the Cobden Centre, we believe liberal free trade is much more important to international social progress than political power. We’ve concentrated on the state’s incompetence in monetary matters so far. It seems over the months and years ahead, as more bad ideas work themselves out in public policy, there will be ever more to say on free trade. We hope you will help us.
The Bitcoin phenomenon has now reached the mainstream media where it met with a reception that ranged from sceptical to outright hostile. The recent volatility in the price of bitcoins and the issues surrounding Bitcoin-exchange Mt. Gox have led to additional negative publicity. In my view, Bitcoin as a monetary concept is potentially a work of genius, and even if Bitcoin were to fail in its present incarnation – a scenario that I cannot exclude but that I consider exceedingly unlikely – the concept itself is too powerful to be ignored or even suppressed in the long run. While scepticism towards anything so fundamentally new is maybe understandable, most of the tirades against Bitcoin as a form of money are ill-conceived, terribly confused, and frequently factually wrong. Central bankers of the world, be afraid, be very afraid!
Any proper analysis has to distinguish clearly between the following layers of the Bitcoin phenomenon: 1) the concept itself, that is, the idea of a hard crypto-currency (digital currency) with no issuing authority behind it, 2) the core technology behind Bitcoin, in particular its specific algorithm and the ‘mining process’ by which bitcoins get created and by which the system is maintained, and 3) the support-infrastructure that makes up the wider Bitcoin economy. This includes the various service providers, such as organised exchanges of bitcoins and fiat currency (Mt. Gox, Bitstamp, Coinbase, and many others), bitcoin ‘wallet’ providers, payment services, etc, etc.
Before we look at recent events and recent newspaper attacks on Bitcoin, we should be clear about a few things upfront: If 1) does not hold, that is, if the underlying theoretical concept of an inelastic, nation-less, apolitical, and international medium of exchange is baseless, or, as some propose, structurally inferior to established state-fiat money, then the whole thing has no future. It would then not matter how clever the algorithm is or how smart the use of cryptographic technology. If you do not believe in 1) – and evidently many economists don’t (wrongly, in my view) – then you can forget about Bitcoin and ignore it.
If 2) does not hold, that is, if there is a terminal flaw in the specific Bitcoin algorithm, this would not by itself repudiate 1). It is then to be expected that a superior crypto-currency will sooner or later take Bitcoin’s place. That is all. The basic idea would survive.
If there are issues with 3), that is, if there are glitches and failures in the new and rapidly growing infra-structure around Bitcoin, then this neither repudiates 1), the crypto-currency concept itself, nor 2), the core Bitcoin technology, but may simply be down to specific failures by some of the service providers, and may reflect to-be-expected growing pains of a new industry. As much as I feel for those losing money/bitcoin in the Mt Gox debacle (and I could have been one of them), it is probably to be expected that a new technology will be subject to setbacks. There will probably be more losses and bankruptcies along the way. This is capitalism at work, folks. But reading the commentary in the papers it appears that, all those Sunday speeches in praise of innovation and creativity notwithstanding, people can really deal only with ‘markets’ that have already been neatly regulated into stagnation or are carefully ‘managed’ by the central bank.
Those who are lamenting the new – and yet tiny – currency’s volatility and occasional hic-ups are either naïve or malicious. Do they expect a new currency to spring up fully formed, liquid, stable, with a fully developed infrastructure overnight?
Recent events surrounding Mt Gox and stories of raids by hackers would, in my opinion, only pose a meaningful long-term challenge for Bitcoin if it could be shown that they were linked to irreparable flaws in the core Bitcoin technology itself. There were indeed some allegations that this was the case but so far they do not sound very convincing. At present it still seems reasonable to me to assume that most of Bitcoin’s recent problems are problems in layer 3) – supporting infrastructure – and that none of this has so far undermined confidence in layer 2), the core Bitcoin technology. If that is indeed the case, it is also reasonable to assume that these issues can be overcome. In fact, the stronger the concept, layer 1), the more compelling the long-term advantages and benefits of a fully decentralized, no-authority, nationless global and inelastic digital currency are, the more likely it is that any weaknesses in the present infrastructure will quickly get ironed out. One does not have to be a cryptographer to believe this. One simply has to understand how human ingenuity, rational self-interest, and competition combine to make superior decentralized systems work. Everybody who understands the power of markets, human creativity, and voluntary cooperation should have confidence in the future of digital money.
None of what happened recently – the struggle at Mt. Gox, raids by hackers, market volatility – has undermined in the slightest layer 1), the core concept. However, it is precisely the concept itself that gets many fiat money advocates all exited and agitated. In their attempts to discredit the Bitcoin concept, some writers do not shy away from even the most ludicrous and factually absurd statements. One particular example is Mark T. Williams, a finance professor at Boston University’s School of Management who has recently attacked Bitcoin in the Financial Times and in this article on Business Insider.
Money and the state: Fact and fiction
Apart from all the scare-mongering in William’s article – such as his likening Bitcoin to an alien or zombie attack on our established financial system, stressing its volatility and instability – the author makes the truly bizarre claim that history shows the importance of a close link between currency and sovereignty. Good money, according to Williams, is state-controlled money. Here are some of his statements.
“Every sovereignty uses currency.”
“Trust and faith that a sovereign is firmly standing behind its currency is critical.”
“Sovereigns understand that without consistent economic growth and stability, the standard of living for its citizens will fall, and discontentment will grow. Nation-state treasuries print currency but the vital role of currency management– needed to spur economic growth — is reserved for central bankers.”
Williams reveals a striking lack of historical perspective here. Money-printing, central banking and any form of what Williams calls “currency management” are very recent phenomena, certainly on the scale that they are practiced today. Professor Williams seems to not have heard of Zimbabwe, or of any of the other, 30-odd hyperinflations that occurred over the past 100 years, all of which, of course, in state-managed fiat money systems.
Williams stresses what a long standing concept central banking is, citing the Swedish central bank that was founded in 1668, and the Bank of England, 1694. Yet, human society has made use of indirect exchange – of trading with the help of money – for more than 2,500 years. And through most of history – up to very recently – money was gold and silver, and the supply of money thus practically outside the control of the sovereign.
The early central banks were also very different animals from what their modern namesakes have become in recent years. Their degrees of freedom were strictly limited by a gold or silver standard. In fact, the idea that they would “manage” the currency to “spur” economic growth would have sounded positively ridiculous to most central bankers in history.
Additionally, by starting their own central banks, the sovereigns did not put “trust and faith” behind their currencies – after all, their currencies were nothing but units of gold and silver, and those enjoyed the public’s trust and faith on their own merit, thank you very much – the sovereigns rather had their own self-interest at heart, a possibility that does not even seem to cross William’s mind: The Bank of England was founded specifically to lend money to the Crown against the issuance of IOUs, meaning the Bank of England was founded to monetize state-debt. The Bank of England, from its earliest days, was repeatedly given the legal privilege – given, of course, by its sovereign – to ignore (default on) its promise to repay in gold and still remain a going concern, and this occurred precisely whenever the state needed extra money, usually to finance a war.
Bitcoin is cryptographic gold
“Gold is money and nothing else.” This is what John Pierpont Morgan said back in 1913. At the time, not only was he a powerful and influential banker, his home country, the United States of America, had become one of the richest and most dynamic countries in the world, yet it had no central bank. The history of the 19th century US – even if told by historians such as Milton Friedman and Anna Schwarz who were no gold-bugs but sympathetic to central banking – illustrates that monetary systems based on a hard monetary commodity (in this case gold), the supply of which is outside government control, is no hindrance to vibrant economic growth and rising prosperity. Furthermore, economic theory can show that hard and inelastic money is not only no hindrance to growth but that it is indeed the superior foundation of a market economy. This is precisely what I try to show with Paper Money Collapse. I do not think that this was even a very contentious notion through most of the history of economics. Good money is inelastic, outside of political control, international (“nationless”, as Williams puts it), and thus the perfect basis for international cooperation across borders.
Money was gold and that meant money was not a tool of politics but an essential constraint on the power of the state.
As Democritus said “Gold is the sovereign of all sovereigns”.
It is clear that on a conceptual level, Bitcoin has much more in common with a gold and silver as monetary assets than with state fiat money. The supply of gold, silver and Bitcoin, is not under the control of any issuing authority. It is money of no authority – and this is precisely why such assets were chosen as money for thousands of years. Gold, silver and Bitcoin do not require trust and faith in a powerful and privileged institution, such as a central bank bureaucracy (here is the awestruck Williams not seeing a problem: “These financial stewards have immense power and responsibility.”) Under a gold standard you have to trust Mother Nature and the spontaneous market order that employs gold as money. Under Bitcoin you have to trust the algorithm and the spontaneous market order that employs bitcoins as money (if the public so chooses). Under the fiat money system you have to trust Ben Bernanke, Janet Yellen, and their hordes of economics PhDs and statisticians.
Hey, give me the algorithm any day!
Money of no authority
But Professor Williams does seem unable to even grasp the possibility of money without an issuing and controlling central authority: “Under the Bitcoin model, those who create the software protocol and mine virtual currencies would become the new central bankers, controlling a monetary base.” This is simply nonsense. It is factually incorrect. Bitcoin – just like a proper gold standard – does not allow for discretionary manipulation of the monetary base. There was no ‘monetary policy’ under a gold standard, and there is no ‘monetary policy’ in the Bitcoin economy. That is precisely the strength of these concepts, and this is why they will ultimately succeed, and replace fiat money.
Williams would, of course, be correct if he stated that sovereigns had always tried to control money and manipulate it for their own ends. And that history is a legacy of failure.
The first paper money systems date back to 11th century China. All of those ended in inflation and currency disaster. Only the Ming Dynasty survived an experiment with paper money – by voluntarily ending it and returning to hard commodity money.
The first experiments with full paper money systems in the West date back to the 17th century, and all of those failed, too. The outcome – through all of history – has always been the same: either the paper money system collapsed in hyperinflation, or, before that happened, the system was returned to hard commodity money. We presently live with the most ambitious experiment with unconstrained fiat money ever, as the entire world is now on a paper standard – or, as James Grant put it, a PhD-standard – and money production has been made entirely flexible everywhere. This, however does not reflect a “longstanding bond between sovereign and its currency”, as Williams believes, but is a very recent phenomenon, dating precisely to the 15th of August 1971, when President Nixon closed the gold window, ended Bretton Woods, and defaulted on the obligation to exchange dollars for gold at a fixed price.
The new system – or non-system – has brought us persistent inflation and budget deficits, ever more bizarre asset bubbles, bloated and unstable banking systems, rising mountains of debt that will never be repaid, stagnating real incomes and rising income disparities. This system is now in its endgame.
But maybe Williams is right with one thing: “If not controlled and tightly regulated, Bitcoin — a decentralized, untraceable, highly volatile and nationless currency — has the potential to undermine this longstanding bond between sovereign and its currency.”
Three cheers to that.
This article was previously published at DetlevSchlichter.com.
Some key US economic data shows visible weakening. The National Association of Home Builders/Wells Fargo sentiment index slumped to 46 in February from 56 in January.
The New York Federal Reserve Bank’s Empire State general business conditions index fell to 4.48 in February from 12.51 the month before.
Also, the yearly rate of growth of housing starts fell to minus 2% in January from 6.6% in the month before. Whilst the yearly rate of growth existing home sales fell to minus 5.1% in January from minus 0.2% in December – the third consecutive month of negative growth.
Furthermore, the Philadelphia Fed business index fell to minus 6.3 in February from 9.4 in January.
Most economic commentators blame the weakening in economic data on bad weather conditions that have gripped much of the US. On this way of thinking the economy remains strong and short setbacks are on account of consumers and businesses putting off purchases. However, this should reverse, so it is held, once the weather improves.
There is no doubt that weather conditions can cause disruptions in economic activity. However, we hold that the recent weakening in the data could be in response to the emerging economic bust brought about by a decline in the growth momentum of money supply (see more details below).
Also, we suggest that the phenomena of recessions is not about the weakness of the economy as such as depicted by various economic indicators, but about the liquidation of various activities that sprang up on the back of the increase in the rate of growth of money supply. Here is why.
An increase in money supply sets in motion an exchange of nothing for something, which amounts to a diversion of real wealth from wealth generating activities to non-wealth generating activities. In the process this diversion weakens wealth generators and this in turn weakens their ability to grow the overall pool of real wealth i.e. weakens their ability to grow the economy.
The expansion in the activities that sprang up on the back of rising money supply is what an economic ‘boom’, or false economic prosperity, is all about.
Note that once there is a strengthening in the pace of monetary expansion, irrespective of how strong and big a particular economy is, the pace of the diversion of real wealth is going to strengthen. Once, however, a slowdown in that pace of monetary expansion emerges, this slows down the diversion of real wealth from wealth producers to non-wealth producers.
This means that various bubble activities or non-productive activities are now getting less support from the money supply – they fall into trouble.
A weakening in bubble activities is what a recession is all about. Irrespective of how big and strong an economy is, a decline in the rate of growth in money supply is going to undermine various uneconomic activities that sprang up on the back of the previous increase in the money supply.
This means that recessions or economic busts have nothing to do with the so-called strength of an economy, improved productivity, or better inventory management by companies.
For instance, as a result of a loose monetary stance on the part of the Fed and the subsequent expansion in the money supply rate of growth various false activities emerge.
Now, even if these activities are well managed and maintain very efficient inventory control, this fact cannot be of much help once the central bank reverses its loose monetary stance. Again, these activities are the product of the loose monetary stance of the central bank. Once the stance is reversed, regardless of efficient inventory management, these activities will come under pressure and run the risk of being liquidated.
Having established that recessions are about the liquidations of unproductive activities, why are they recurrent? The reason for this is the central bank’s ongoing policies that are aimed at fixing the unintended consequences that arise from its earlier attempts at stabilising the so-called economy.
On account of the time lags from changes in money to changes in economic activity the central bank or the Fed is forced to respond to the effects of its own previous monetary policies. These responses to the effects of past policies give rise to the fluctuations in the rate of growth of money supply and in turn to recurrent boom – bust cycles.
We suggest that a fall in the yearly rate of growth of AMS from 14.8% in October 2011 to 8.1% in January 2014 poses a threat to various bubble activities that emerged on the back of an increase in the yearly rate of growth of AMS from 2.2% in June 2010 to 14.8% in October 2011.
Given the fact that there is a time lag between changes in money and changes in economic activity it is quite likely that the increase in the growth momentum of AMS during June 2010 to October 2011 is still dominating the economic scene.
As time goes by however, we suggest that a fall in the growth momentum of AMS during October 2011 to January 2014 can be expected to assert its dominance. This will be mirrored by the decline in bubble activities and in turn in various economic activity indicators.
“The co-authors began working on this book in 1974, just after the termination of President Nixon’s controls in the United States. Since that time, we have examined over one hundred cases of wage and price controls in thirty different nations from 2000 BC to AD 1978..
“We have concluded that, while there have been some cases in which controls have at least apparently curtailed the effects of inflation for a short time, they have always failed in the long run. The basic reason for this is that they have not addressed the real cause of inflation which is an increase in the money supply over and above the increase in productivity. Rulers from the earliest times sought to solve their financial problems by debasing the coinage or issuing almost worthless coins at high face values; through modern technology the governments of recent centuries have had printing presses at their disposal. When these measures resulted in inflation, the same rulers then turned to wage and price controls.”
- Robert L Schuettinger and Eamonn F Butler, ‘Forty centuries of wage and price controls: how not to fight inflation’ (The Heritage Foundation, 1979).
It emerged last week that the average asking price for a property in the UK had risen above £250,000. Superficially this sounds like good news for home-owners. In reality, the only benefit goes to government, which enjoys a higher tax take from stamp duty at 3% as opposed to the 1% rate that applies to property purchases below the £250K level – assuming people can be coerced into wanting to move. Unless home-owners are down-sizing, they merely have to pay more for the houses into which they move. And higher house prices make life just that little bit more miserable for a younger generation already plagued by the rising cost of education, the likely burden of student debt, and an increasingly competitive jobs market. And anyone trying to join the long-standing cult that is British property ownership has reason to be wary of the government’s latest attempt to inflate the property bubble by encouraging reckless credit provision via the 5% deposit ‘help to buy’ scheme. It’s almost as if the financial-crisis-triggered-by-a-bursting-property- bubble never happened.
As Schuettinger and Butler point out in their history of wage and price controls, government- provoked inflation is nothing new. The Roman Emperor Nero (AD 54-68) responded to growing economic problems by devaluing the currency. The devaluation started relatively modestly but accelerated under Marcus Aurelius (AD 161-180) when the weights of coins were reduced. “These manipulations were the probable cause of a rise in prices,” wrote Levy. The Emperor Commodus (AD 180-192) turned to price controls and decreed a series of maximum prices, but things deteriorated and the rise in prices became “headlong” under the Emperor Caracalla (AD 211-217).
Egypt was the imperial province most severely affected. During the fourth century, the value of the gold solidus changed from 4,000 to 180 million Egyptian drachmai. Levy also attributes the grotesque rise in prices which followed to the increase of the amount of money in circulation. The price of the same measure of wheat in Egypt rose from 6 drachmai in the first century to 200 in the third century; in AD 314, the price rose to 9,000 drachmai and in AD 334 to 78,000. Shortly after AD 344 the price had reached more than 2 million drachmai. Other provinces endured similar inflations. Levy wrote:
In monetary affairs, ineffectual regulations were decreed to combat Gresham’s Law [bad money drives out good] and domestic speculation in the different kinds of money. It was forbidden to buy or sell coins: they had to be used for payment only. It was even forbidden to hoard them ! It was forbidden to melt them down (to extract the small amount of silver alloyed with the bronze). The punishment for all these offences was death. Controls were set up along roads and at ports, where the police searched traders and travellers. Of course, all these efforts were to no purpose.
Perhaps the most notorious attempt to control wages and prices took place under the Emperor Diocletian. Commodity prices and wages reached “unprecedented heights” shortly after he assumed the throne in AD 284. The Empire’s economic troubles have been attributed to a vast increase in the armed forces (to repel invasions by barbarian tribes); to a huge building programme of questionable value; to the consequent raising of taxes and the employment of ever more government officials; and to the use of forced labour to accomplish much of Diocletian’s public works programme. (Thank goodness the current UK government isn’t intent on squandering over £40 billion it doesn’t actually have on a high speed rail link of dubious utility.)
Diocletian, on the other hand, attributed the inflation entirely to the “avarice” of merchants and speculators. Some things truly never change.
What is undeniable is that as taxes rose, the tax base shrank, and it became increasingly difficult to collect taxes, resulting in a vicious circle. (Happily, the Liberal Democrats in coalition with the current government have a progressive attitude towards soaking the rich.)
Probably the single biggest cause of Diocletian’s inflation was his debasement of the coinage. In the early Empire, the standard Roman coin was the silver denarius. Its value had gradually been reduced in the years leading up to his reign as emperors issued tin-plated copper coins which still kept the name “denarius”. Under Gresham’s Law, silver and gold coins were hoarded and left circulation.
During the 50 years ending in AD 268, the silver content of the denarius fell to one five- thousandth of its original level. Trade was reduced to barter and economic activity stagnated. The middle class was almost obliterated. To overcome the baleful influence of his bureaucracy, Diocletian introduced a system of taxes based on payments in kind, which had the effect of destroying the freedom of the lower classes and tying them to the land. Then came currency reform, and the Edict on prices and wages. Historian Roland Kent:
Diocletian took the bull by the horns and issued a new denarius which was frankly of copper and made no pretence of being anything else; in doing this he established a new standard of value. The effect of this on prices needs no explanation; there was a readjustment upward, and very much upward.
Diocletian had the option of either inflating – minting increasingly worthless denarii, or to deflate – in the form of cutting government expenditures. He chose to inflate. He also chose to fix the prices of goods and services and suspend the freedom of the people to decide what the currency was actually worth. He fixed the maximum prices at which beef, grain, eggs and clothing could be sold, and the wages that workers could receive, and prescribed the death penalty for anyone who disposed of his wares at a higher figure.
Less than four years after the currency reform associated with the Edict, the price of gold in terms of the denarius had risen by 250%. By AD 305 the process of currency debasement began again. Levy:
State intervention and a crushing fiscal policy made the whole empire groan under the yoke; more than once, both poor men and rich prayed that the barbarians would deliver them from it. In AD 378, the Balkan miners went over en masse to the Visigoth invaders, and just prior to AD 500 the priest Salvian expressed the universal resignation to barbarian domination.
David Meiselman, in a foreword to ‘Forty centuries..’ writes as follows:
What, then, have price controls achieved in the recurrent struggle to restrain inflation and overcome shortages ? The historical record is a grimly uniform sequence of repeated failure. Indeed, there is not a single episode where price controls have worked to stop inflation or cure shortages. Instead of curbing inflation, price controls add other complications to the inflation disease, such as black markets and shortages that reflect the waste and misallocation of resources caused by the price controls themselves. Instead of eliminating shortages, price controls cause or worsen shortages. By giving producers and consumers the wrong signals because “low” prices to producers limit supply and “low” prices to consumers stimulate demand, price controls widen the gap between supply and demand.
Despite the clear lessons of history, many governments and public officials still hold the erroneous belief that price controls can and do control inflation. They thereby pursue monetary and fiscal policies that cause inflation, convinced that the inevitable cannot happen. When the inevitable does happen, public policy fails and hopes are dashed. Blunders mount, and faith in governments and government officials whose policies caused the mess declines. Political and economic freedoms are impaired and general civility suffers.
The chart below, courtesy of Church House, shows the history of the most important price in the UK economy – the price of money, as set by the central bank (as opposed to the market):
The chart below, courtesy of the St Louis Federal Reserve and Incrementum AG, shows the expansion of the US monetary base since 1918; the three separate iterations of QE are marked:
- The (government-sanctioned) price of money hasn’t been this low in 300 years.
- The US monetary base has exploded. (We concede the role of private banks in money creation too, so we watch the velocity of money carefully.)
- As Robert Louis Stevenson once said, “Sooner or later everyone sits down to a banquet of consequences.”
- We hold gold.
This article was previously published at The price of everything.
When US money supply measured by M2 stood at $11 trillion in December 2013, I calculate that total broad money of the next largest 50 countries ranked by GDP amounted to the equivalent of a further US$67 trillion at current exchange rates. And that’s only on-balance sheet: we must add in global shadow banking, estimated by the Financial Stability Board to have been an extra $67 trillion in 2011, probably about $75 trillion today, given its recent rapid growth in China. So when we look at US broad money supply, we should be aware there is a further mountain of money thirteen times as big ultimately based on the dollar.
As long as bank lending, industrial investment and consumption are all expanding, the sun smiles. It’s when it stops that problems arise, and why markets reacted badly to the idea of tapering and are increasingly nervous about China’s credit bubble and attempts to rein it in.
More specifically the danger arises from a slow-down and possible reversal of cross-border investment, particularly with emerging economies. Between 2000 and 2007 investment from advanced economies into emerging markets grew at an annual compound rate of about 18%, and between 2008 and 2011 it slowed to about 5% (McKinsey, 2013). The beneficiaries of this investment, global financial assets (all equities, bonds and loans) averaged growth of only 1.9% annually in dollar terms between 2007 and 2011. If we could measure it today the overall return would probably be a big fat zero.
So whatever analysis of individual countries might tell us, it has been easy to miss the threat of a deepening global recession, a risk increased by diminishing cross-border flows. What a time for the Fed and the Peoples Bank of China to decide to reduce the rate of monetary expansion for the two largest economies! These actions are too late to achieve the hoped-for orderly exit from excessive monetary expansion.
If cross-border investment flows reverse, as they are now threatening to do, banks and multinational businesses will run for cover and the carry-trade will rapidly unwind. And when fear of losses finally triumphs over greed for profits the weaker currencies are usually the first to suffer.
The relationship between these currencies and the dollar is now being tested in the markets. Eventually, of course, the Fed will have to resume unlimited monetary expansion to buy off a global economic and financial crisis. In doing so it will probably take comfort in the precedent set when dealing with Lehman. We cannot be so certain of the effects of China’s future monetary policy, other than knowing that in troubled times Chinese citizens turn to gold, along with all the other Asian peoples acutely aware of gold’s ability to store wealth through difficult times.
The last crisis was just the banks. This time we are looking at a potential popping of a full-blown global currency bubble, which was generated as the solution to the last crisis. And this new bubble is all supported on an inflated US monetary base of $3.8 trillion. That’s bubbly gearing of nearly 40 times, or 163 times the monetary base on the eve of the Lehman crisis.
I have begun work on a new book.
It is called Bitcoin – The Future Of Money? Once again I am funding it with Unbound.
As the more observant will deduce, it is about the new form of digital money known as Bitcoin.
You might of the view that Bitcoin is up there with tulips and South Sea companies in the greatest-ever-bubbles parade.
Alternatively, you might feel that this new digital cash technology is going to change the way we transact. Not only that, it will alter the very nature of money with huge social, political and economic ramifications.
There is also the third possibility – which cannot be ignored – that you couldn’t give a flying #$@*%! either way.
The story of Bitcoin is an amazing one – from its birth amongst the ‘cypherpunk’ revolutionaries, who believed they could change the world through computer hacking and cryptography, to its million-fold rise in price to the mystery surrounding its creator, who may as well have be aboard the Mary Rose for all we know about him.
I’ll tell this story, I’ll take you on a walk along the Silk Road (the Amazon-like website where you can buy what we’ll call ‘black market goods’), I’ll consider how Bitcoin might change the world, if at all, whether you should buy some and how to, and, most of all, I explain what the bloody thing is and how it works.
Unlike Life After The State, I am not planning to solve all the world’s problems this time around, so you should see a comparatively quick return on your money in the form of a book.
Please help make it happen by pledging here.
We only launched last week and we already over 70% funded, thanks to people’s excitement and generosity. It is happening in record time.
Both fame and glory await you when you pledge and get your name in the back of this seminal work*.
The link is here in case you missed it.
With fond regards wherever you are in the world,
* Most of the statements in the sentence are almost certainly not true
Imagine, if you will, a small, isolated hamlet where the daily round proceeds in harmony with the gentle rhythm of agriculture. Ground is tilled, seed is sown, crops are harvested, dried, threshed, and milled, each in their due season. In the lush, green meadows a little higher up the valley cows are impregnated before their calves are led docilely off to slaughter – both for their meat and for their cheese-making stomach enzymes. The kine turn the sweet grass which covers the pasture into much-needed fertilizer for the arable lands and, twice daily, milking takes place according to its own timeless routine.
Into this bucolic idyll now intrudes an ambitious village headman who has heard that he can further his own lot in life if he erects a series of shrines to the glory of the Emperor who is honourably busying himself with the mandate of heaven, far away in the stately pleasure dome of his Celestial Palace. Work begins at once, employing both those locals who have too little to do and, in due course, attracting itinerant labourers to the village.
Since the business of shrine building produces nothing tangible of itself – no new stands of millet or of teeming paddies of rice, no additions to the lowing herds of cattle – it is necessary that all those set to constructing them be given a share of the existing produce of the land. Thus, the biddable farmers are constrained to eat less heartily of the fruits of their own labours so that the community’s meritorious contribution to the cult of the Emperor may better be advanced. Not wishing to be seen as grasping, those toiling to break the rocks and pile up the cairns which constitute the sacred monuments are also persuaded that they, too, should forego the immediate enjoyment of the entirety of their daily wage and should also set some of it aside as their own offertory act.
So as to recognise the sacrifice each has made – a propitiation which each fully expects will earn him a future reward in something a little more material than the Emperor’s gratification alone, though from whence exactly none can truly say – the village scribe diligently records the size of each implicit donative against the name of its pious contributor in his scrolls (implicit since each has already been used up as surely as if they were burned in some great communal hecatomb). Slowly then and at no little personal cost in denial, if not outright privation, this local register of deeds grows longer, keeping as it does a tally on the mounting sum of savings being laid down by the dutiful and the diligent.
Imagine then, the consternation which ensues when, one fine spring morning, a courier rushes into the market square and, gathering his breath, proceeds to read out the latest proclamation from an imperial capital so far removed from their daily experience that few in the village have any firm conception of either its extent or its location. The Most Venerated Prince has decided, the messenger declares, that the count of the shrines being dedicated to the royal personage is become too large and that His Highness’ most farseeing haruspices and horoscopists have persuaded Him that it is unseemly for an earthbound divinity such as He to be seen to rival in this way the worship of the true Immortals in all their celestial splendour.
Henceforth, all such construction is to be halted and no more oblations are to be made in His most blessed name. No one, the herald continues, is to ‘save’ any further, upon pain of exciting both the Emperor’s awful displeasure and the thunderous anger of the Sky Gods whom He, too, serves in his turn. Instead, each must consume up to the very limit of his income and entertain no further thought of laying in a store against a future already so lavishly provisioned for.
But, goes up the cry, where will we, His Majesty’s most loyal temple builders, earn our bread, if the farmers do not continue to set aside our due portion? Are we, too, to follow the plough tomorrow? And, if so, who will grant us the lands, the tools, the skills to enable us to do so? All we have to hand are these well-used chisels and thrice-repaired picks. All we otherwise possess is a certain facility in the mason’s art. Surely these will not now serve to fill our empty bellies and still the crying of our hungry children?
And, for our part, how will we achieve any measure of recompense for the manifold portions already foregone, howl the farmers who have come to realise that their ‘savings’ are nothing but an empty twirl of the calligrapher’s brush, that they represent no bounty – present or prospective – to see them through their dotage or to pay their daughters’ dowries? Indeed, beyond a sterile list of claims to ownership of the many useless piles of now deconsecrated rubble, to what has all their devout abstinence amounted, they wonder. Will these bring forth butter or bread on which to spread it? Will it give us flax for our wives to spin into clothing, or hide to keep us shod, they quail?
“Be still, you wretches!” comes the haughty retort of the imperial mouthpiece. “His Most Elevated Puissance has become aware that the world is out of balance, that Yin does not match Yang, that there is too much investment in tomorrow and not enough indulgence here today. This must cease forthwith!”
“What is it to Him if you did not fashion mills to grind your corn or locks to render navigable your streams – and so increase the size and richness of your coming reward – but instead you sought to curry the royal favour by erecting rough-hewn altars to His cult on every rutted cart track and every dusty crossroads? The time has come, His most learned astrologers have ruled, to eat your way to wealth and for those who have hitherto laboured in what they misguidedly took to be His service to do the same for you farmers in your own homes. His mages, in their unfathomable wisdom, have determined that this way, and this way only must be followed: that the erstwhile builders will hew your wood and carry your water, they will sweep your paths and carry in the tapers to light your rooms at night. In short, they shall come to share your table openly with you and, in so doing, will ensure that it straightways will groan under the weight of all that greatly augmented whole that will instantly appear to be laid upon it.”
It was realized—if grudgingly—that this arrangement would not be entirely without merit: the farmers were used, after all, to feeding the temple builders and this way they would at least be free to devote more of their energies to higher order tasks and less to menial ones in return. Nevertheless, it came as a rude awakening to one and all to realise that where they thought they had been piling up the riches with which to ease their lives in future, all of their sacrifice had availed them naught and they would have to start again from their beginnings, poorer if hopefully wiser.
No word was said as to what the scribe should do with all those carefully guarded scrolls, now rendered utterly worthless by dint of the Imperial whim. The man himself was cautious enough quietly to make his exit, long before he could be blamed for what he had only wrought at the behest of his masters.
‘Feeling the Stones’, but Drowning Still
Ok, so, folksy analogies aside, we have to confess that not every ‘investment’ laid down in modern China is a folly; that not every plant operates far short of its capacity; that not all ‘profits’ are an artefact of hidden subsidies, false accounting, the shameless exploitation of captive savings, and a vast monetary influx, as in our little parable.
Nevertheless, in far too many instances this has indeed become the case. Moreover, the situation is far more fraught than was that which prevailed in our simple village economy because the scribe’s register of ‘savings’ there have as their actual counterpart the liabilities of the financial system. These, as we know, are not simple transactions recorded between two directly consenting counterparties, but are the nodes in a web of a myriad of subsequent interdealings whose complexity is beyond comprehension and whose strands comprise the means of circulation of goods and services everywhere they would go within the economy.
Thus, it is all well and good to declare by way of some sort of macroeconomic truism that we ‘need’ less investment and we ‘need’ more consumption and that the Kuznetsian Y will remain unchanged if C rises and I falls in a like manner and in the same timeframe, but that exquisitely interconnected, ever-evolving meta-organism which is an economy cannot be reduced to such a trivial game of adding more of one thing here and taking away some of another there as if we were simply hanging baubles on a Christmas tree.
For a start, the ability to consume must be in some way linked to the fact of having completed a prior act of production, whether we look at how one acquires an ‘effective’ demand upon such product or how one gains access to the requisite supply. Where that linkage is broken, as when credit creation or money printing tries to circumvent this necessary order of precedence, the consequences are always invidious and usually pernicious, to boot.
Secondly, each particular action, whether of consumption or production, is only sustainable – i.e., can be undertaken without unduly limiting the future possibilities for either its repetition or amendment – to the extent that it is integrated into the greater whole of all such actions, a condition which implies not just the instantaneous, but the intertemporal coherence of intentions.
Thirdly, each is dependent not only on the shifting sands of individual subjective preference, but its commission typically depends on the purposeful employment of both specific human skills and a dedicated, non-versatile endowment of capital.
Fourthly, much as the curvature of spacetime gives rise to the gravitational effects on a mass which then curves that same spacetime, each action cannot fail to effect changes in the milieu in which all subsequent actions must be planned and carried out. Thus, in this most Heraclitan of worlds, all is flux, meaning that not even the most bolted down, immovable hunk of plant or machinery should ever be confused with ‘capital’ per se (that would be to commit the same kind of error of association as is entrained in Marx/Ricardo’s labour theory of value and its ‘cost of production’ school among the resource analyst community).
Nor should it be considered to have any meaningful degree of ‘permanence’ simply because of its physical durability: function is what matters, not form and, moreover, it should never be forgotten that the true function of capital is to produce positive net income, not the things which we (mostly) trade onwards to others in order to assure receipt of that income. Indeed, we would do better to disembody our conception of capital entirely and to view it solely as a collection of property rights (including the primal right of self-ownership) from whose use we aspire to generate that net income over time and whose composition we must constantly adjust to fit the ever-changing circumstances in which it must be employed and which its very employment also alters.
Finally, in our intimately financialized economy, each one of our undertakings leaves its own trail of obligations given and received, each of which pathways of itself forms the foundation for yet other layerings of promise and contractual delivery. Thus, were our hamfisted attempts at puppeteering to cause a certain critical level of disruption to the operation of and – perhaps more importantly – the faith in one of these trackways, a cascade of failure could all too easily result turning as we Austrians like to say, an initiating monetary problem into a real one.
Thus, it borders on the facile to presume to re-arrange the pawns on the macroeconomic chessboard by lifting them off and putting them back, one by one and regardless of the actual progression of the game, but it is an exercise which not even the grandest of grandmasters could accomplish to orchestrate the march of the pieces from one such position to another not only while they are all moving at once but, indeed, doing so according to their individual expressions of will and, moreover, while they are simultaneously changing not only their own shapes and capabilities for movement, but redrawing the very dimensions of the board as they do.
China – or should we rather say, the individual Chinese – would undoubtedly be better off in an environment where more room was allowed for the ‘spontaneous order’ of consumer sovereignty under property rights to emerge and less was reserved for the corrupt gaming of central diktat, but to avow this is not to assume either that the transition will be seamless, much less painless, nor to accept that it can be so ordained simply by exchanging one set of fiats and public choice manoeuvrings for another.
But, never underestimate the penchant of the crude Keynesians for patent nostrums, state worship, and the elevation of hidden-cost collectivism to a guiding principle. Thus it is that, among the encomia for reform, we hear such idiocies as the following, oft-parroted, Cargo Cult wishfulness:-
[China should] Reform the Hukou system through creating a path for rural migrants to gain affordable housing and social services in urban areas. This could unlock much more consumer spending because, at the moment, some 270 million migrants who lack access to these services are forced to save hard to pay for their families’ education, healthcare and housing, etc…
-which is to imply nothing less than if the migrants themselves do not have to save, no-one else will either since the tutelary welfare state is, after, all a Tooth Fairy!
‘Cutting the Wrist’ with a Blunted Blade?
In the present vogue for voicing the previously inexpressible – presumably as part of the strategy to persuade the diehards that change is an unavoidable imperative – one of the New Men of the reform movement, Fang Xinghai, ex-Shanghai, World Bank, and Stanford, warned that many small banks were horribly over-reliant on wholesale sources of funding – to the tune of no less than 80% in some cases, Fang alleged – thus making them highly vulnerable to a run and of then acting as the ‘triggers’ in a possible asset price ‘cascade’.
To say such things openly is indeed to peer into Pandora’s Box. Total Chinese banking assets currently stand at some CNY147 trillion, around 2 ½ times GDP. As such, they have doubled in the past four years of increasingly misplaced investment and frantic real estate speculation, adding the equivalent of 140% of average GDP – or, in dollars, $12.5 trillion – to the books. For comparison, over the same period, US banks have added just less than $700 billion, 4.4% of average GDP, 18 times less than their Chinese counterparts – and this in a period when the predominant trend has been for the latter to do whatever it takes to keep commitments off their balance sheets and lurking in the ‘shadows’!
Indeed, the increase in Chinese bank assets during that breakneck quadrennium is equal to no less than seven-eighths of the total outstanding assets of all FDIC-insured institutions! It also compares to 30% of Eurozone bank assets (which are broadly unchanged over our chosen horizon, but which do represent an even more scary 320% of GDP and, in many cases dispose of worryingly scanty tangible equity ratios, q.v. below).
Published NPL ratios are reassuringly low and, as a result, earnings seem wonderfully robust, but it simply defies belief to accept either of these at face value, given that we know the Chinese leadership itself is terrified at the state of the nation’s finances.
It is for this reason, as much as any other, that we will believe all the brave talk about capital account liberalization and exchange rate reform when we see it. It would be simply too dangerous for a country stuffed to the gunnels with Ponzified finance raised against a plethora of underproductive assets and overpriced properties. If the PBOC wants to see its $3.7 trillion reserve stash evaporate amid a flirtation with becoming the 1997 Thailand of the current decade, we suggest it proceeds to abolish its controls at its earliest convenience.
It is too early to be justifiably pessimistic and too tempting to let scepticism shade into cynicism, but no-one can readily deny that the implementation of all these much-vaunted reforms will not take place without a struggle: too many losers will be created, who must either be compensated or else outweighed in influence by the new winners who emerge.
Take the relaxation of the one-child policy. We already harbour some doubts about just how much pent-up Maternal Instinct there exists in a nation of increasingly professionalized, materially better-off women (a group for whom the indisputable global precedent is that they voluntarily rein in their fertility) whose dream of owning a suitable home in which to raise the first, much less the second, child is ever less realizable thanks to China’s soaring property prices.
On top of this, it has already been admitted by the ruling National Heath and Family Planning Commission that the policy will be left largely to the discretion of lower levels of government to enact, that “there will not be a unified timetable” in recognition of the fact that “preparations or conditions might not be mature in some regions”.
We might suspect that Hukou reform will be seen to require a similar, locally-sensitive and hence inherently piecemeal enactment. Shame about all that ‘consumption’ we might have to forego among those looking forward to cracking open a bottle of Maotai the minute they receive their state pension booklet.
Then there is the ingrained habit which will be hardest of all to break: namely that the facilitation of shrine building – sorry, ‘investment’ – is the raison d’être of being a local government official. Take the report from this week’s, post-Plenum edition of First Financial News which pointed out that the joint spending plans of ten Chinese provinces amounted to a stupefying CNY40 trillion – or 80% of nationwide GDP! Clearly they did not get the latest memo from Chairman Xi.
Before leaving the topic of China, there is just one other faint concern to address; viz., the demotion of the previously ubiquitous champion of reform, Premier Li, almost to the status of Unperson as his superior, President Xi, conversely, has undergone a veritable apotheosis in recent weeks.
Though not quite airbrushed from the May Day balcony shot, Li has been obviously and humiliatingly relegated to the inside pages of late, having conducted such pressing duties as entertaining the Romanian PM on the sidelines of a conclave of central and eastern European leaders in the throbbing heart of Uzbekistan and of chairing a State Council meeting whose agenda read like the trailer for an edition of the BBC’s consumer affairs programme ‘Rogue Traders’ at which our man set his face firmly against the evils of counterfeiting and the future sale of ‘shoddy’ goods. (There goes the Chinese Mittelstand, we are tempted to observe).
Though much has been made of the significance of the newly-instituted Central Leading Committee for the Comprehensive Deepening of Reform (don’t you just revel in the wilder flights of Socialist Newspeak?) and of its possible role in stymieing the local cadre-friendly NRDC, there is a growing suspicion that Li himself will not be selected to head it. If such whispers have any merit to them, this would mean that Xi’s thirst for personal power has already come at the expense of the better co-ordination of the reform push. Watch this space.
An article for the Wall Street Journal …
Last week the U.K.’s Conservative, Labour and Liberal Democrat parties got together to administer a Flodden-style thrashing to Alex Salmond’s dream of an independent Scotland using the pound. But there’s a problem: short of an actual Battle of Flodden, what exactly could a Westminster government do to stop the Scots from using the pound?
Imagine walking along Edinburgh’s Royal Mile in a newly independent Scotland. You want to buy a Bay City Rollers CD as a souvenir and you have a fiver issued by the Bank of England in your pocket. If you can find a vendor willing to take that English note and give you the CD in return, the English authorities would be no more able to prevent the transaction taking place than the U.S. Treasury is to stop rickshaw drivers in Nepal from taking dollar bills in exchange for rides.
There is also nothing necessarily to stop a Scottish government conducting its business in sterling, euros, or whatever else. But it would need to be able to get hold of the requisite sterling, euros, or whatever else. A government that issues its own legal tender has three ways of getting the money it needs to fund its activities: It can print it, it can borrow it, or it can tax it.
Continue reading …