A brilliant video from our friends at SaveOurSavers, celebrating 15 years of the Monetary Policy Committee:
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The debate over taxing the rich has reached new depth in the United States with a true man of letters entering the fray. Depth, that is, as in low point. What the essay by acclaimed and popular novelist Stephen King lacked in profundity it made up for in profanity: Tax me, for f@%&’s sake, was Mr. King’s eloquent plea to the government he so admires. One of the freedoms that Americans of any income bracket still enjoy is the freedom to give more to the government than the government already takes from them by force. If you think that the government can spend your money better than you can, you are free to write them an extra check each year and hand it over with your tax return. King grudgingly acknowledges that he, like everybody else, has that right but that is not enough for him. He wants to see the state take more from ‘rich’ people, himself included, by force, and thus put it to better uses than the rich people themselves ever could. The essay is a bizarre document of economic illiteracy, political naivete, plain arrogance and bad language. Of course, Mr. King and his ‘liberal’ Hollywood friends, like Steven Spielberg, know how to put their wealth to good effect. They fund fire departments and run loss-making radio stations. But not all rich people are that enlightened. There are some who also “give their money away”, such as the hated Koch brothers who fund libertarian think tanks (Cato) or fund independent, coeducational schools, such as Deerfield Academy. For these deranged people we thankfully have a government that has the power to tax, take the wealth from these retards and puts it to all the good uses that only government (and the Stephens, King and Spielberg) can really appreciate. But even worse, there are those rich people who do not even “give their money away” but who – can you believe this? – invest it. They expect to make a return on it. For themselves! Sometimes even by investing abroad. (How unpatriotic!) With proper taxation we could get a better society with fewer and smaller investment portfolios and more government spending. Who can’t see the beauty in that? But here is a real highlight:
To which the proper answer, in Stephen-King-lingo, would be: Why the f@%& just 50%, Stephen? Why not 75%? — Well, come to think of it, why not 80% or 90%? Let’s look at one of those enlightened places where the rich have for some time been paying – what’s the phrase, again? – their “fair share” of 50 percent or thereabout: France. According to King’s logic this must be a workers’ paradise by now, complete with great state schools, social mobility for children of all backgrounds, all-round social harmony and a balanced budget. Maybe, Mr. King, you should leave Planet Hollywood for a minute, buy yourself a first-class ticket to France and look for yourself. Meanwhile, the debate in France is all about how to tax the ‘rich’ more. In progressive France, Mr. King’s ideas are way behind the curve. They seem positively, well, reactionary. “50% taxes for the rich? Stephen, mon ami, what are you? A Republicain?” Soon-to-be President Francois Hollande suggested that upward of a million euro in income, the tax should be 75%, while his left-wing challenger, Jean-Luc Melenchon suggested that from a certain level the tax should be 100%, meaning that a maximum income is established, upwards of which everything will be taxed away and go to the state. You see, Stephen, that is the problem with a ‘fair share’. Fairness is in the eye of the beholder. What Stephen King and his rich ‘liberal’ friends don’t get is this: the government never has enough money. The state cannot handle money, period. It needs more and more. That is the nature of the state, in particular the nature of a modern social-democratic state that depends on the votes of the masses. Every prosperous and peaceful society depends on social cooperation. Social cooperation has to be voluntary and contractual and therefore has to be based on the institution of private property. Our problem – in the U.S. and in France and elsewhere – is that we have too much government, which, by definition, is the negation of liberty, and which always replaces voluntary and free interaction with forced reallocation of resources and forced redirection of human action. The problem is not that the state has too little funds but that it has too much power. But I doubt that Mr. King nor any of his friends have any understanding of what makes a prosperous and free society. As an example of the social mobility that was supposedly once possible in America thanks to government, Mr. King cites Barack Obama. I guess that is his idea of what America needs: lawyers, community organizers and politicians. And that is supposed to be the American dream? Such opinions are indicative of the intellectual decline that drives our social and economic decline: according to our opinion moulders, politicians are better than businessmen, charity is better than business, taxation is better than investing. “Whom the gods would destroy, they first make mad.” In the meantime, the debasement of paper money continues. This article was previously published at Paper Money Collapse. An excellent article from Amity Shlaes:
Shlaes goes on to consider gold’s real record and the recent debate between Ron Paul and Paul Krugman. I recommend the whole article. IN THE BLUE CORNER… *Professor Paul Krugman belongs to a rather elite group of economists: those who have received the Nobel memorial prize. In his case, it was for “his analysis of trade patterns and location of economic activity”, a no doubt fascinating but also highly specialised topic.[1] Outside of academia, Krugman is best known for his outspoken views on contemporary US economic policy, in particular his view that the US monetary and fiscal authorities have not done nearly enough to date to stimulate the chronically weak economy into a strong recovery, notwithstanding TARP, zero rates, QE1, QE2, nationalising Fannie/Freddie, etc. The crux of his argument is that the problems associated with excessive debt and leverage are best addressed through additional debt and leverage. While that may defy basic logic, don’t worry, Krugman has the equations required to prove this assertion. All you need is a PhD and you, too, will learn to cook up a free lunch. IN THE RED CORNER… *Texas Rep. Ron Paul has been a tireless advocate of sound money and fiscal conservatism for decades. In early 1982, following the 1970s stagflation and brief, parabolic rise in the gold price to $850/oz, he was appointed a member of President Reagan’s Gold Commission, tasked with studying whether the US should, and how it might, re-establish the dollar’s pre-1971 link to gold. More recently, Rep. Paul has been advocating cutting fully $1tn from the federal budget as early as 2013. (Read that carefully: He is advocating an outright cut of $1tn, not merely a reduction in already authorised spending increases. In Washington-speak, ‘cutting’ means, ‘increasing by less, according to our own estimates, which tend to undershoot reality by a significant margin’.) As such, in this debate between Prof. Krugman and Rep. Paul, we have the far ends of the policy spectrum represented: those who encourage more debt and those who don’t. What follows is my citation, translation and interpretation of what I regard as the most interesting parts of the debate. Before continuing, I recommend that my readers view the debate for themselves, which runs about 20 minutes and makes for entertaining viewing at times.[2] DING!Rep. Paul was first to present his views, emphasising his general belief in free-markets and limited government, and highlighting specifically his view that the Federal Reserve cannot possibly know how to set the level of interest rates more effectively than a free market in money could do. In doing so, Rep. Paul was channeling another Nobel prize winning economist, Friedrich Hayek, who argued in his famous Nobel speech, The Pretense of Knowledge, that power confers an illusion of knowledge on those in a position to wield it.[3] Prof. Krugman responded that it is impossible to leave interest rates to the market because modern money is highly complex and requires management. As an example, he cited the repo (or repurchase) market, which comprised an important part of the so-called ‘shadow banking system’ thought by many to be responsible for the 2008 financial crisis. I find this to be an odd line of argument, because the Fed is the banking system regulator and in the years leading up to the crisis it regularly compiled and published repo market data. The Fed was thus fully aware of the rapid growth of the repo market but failed to appreciate that an abrupt decline in collateral values for mortgage-backed securities would cause the interbank lending market to seize up. Krugman has thus offered up an example of regulatory incompetence rather than a reason for why central banks should set interest rates. Krugman’s next point was that while he “believes in free markets” he does so only up to a point, because the “markets must be managed”. Of course this implies that Krugman believes that he and his fellow neo-Keynesians know where to draw the line between the “free” part and the “managed” part. No doubt he has the equations to prove this too. As an example, he cites the occurrence of depressions: “Depressions are a bad thing for capitalism.” It is difficult to disagree with that statement, of course, but is this a valid line of argument? If we all agree that depressions are bad, then shouldn’t the discussion be about what causes them in the first place? Let’s return to the point made above: if excessive money growth (via repo and otherwise) was a key contributing factor to the crisis, and if the Fed was in charge of the money supply, then shouldn’t we consider the possibility that Fed policy caused or, at a minimum, contributed to the crisis? You can’t blame ‘free-markets’ for causing the crisis when the market in question is one of the most highly regulated and when the Federal Reserve looks the other way while repo and other money-equivalents grew exponentially in supply for years.[4] “WE DON’T NEED TO WORK ANY MORE. JUST PRINT MONEY!”The discussion then turned to contemporary US debt dynamics. When asked just how much additional debt the US could safely accumulate, Krugman responded without hesitation, “We’re not anywhere close to a red line.” Given that the US total government debt to GDP ratio has now risen through 100% and continues to grow rapidly, that struck me as a breathtakingly audacious statement. Krugman did then qualify it, saying that debt/GDP in excess of 130% might be problematic. Well how on earth can he know that? How could anyone? And has it not occurred to him that, at the current rate of growth, the debt/GDP ratio could easily increase to 130% in just a few years’ time? Using his own words and figures, does 100% and rising really qualify as “not anywhere close to a red line”? Hardly. Rep. Paul was quick to pounce on Krugman’s assurance that we had nothing to fear from the continuing rise in debt. He pointed out that other countries are not obliged to hold dollar reserves in exchange for exporting goods and services to the US. They have the option to diversify into other currencies or into real assets, such as natural resources or even gold. If we are so certain that other countries will hold our dollars and finance our debt indefinitely at low interest rates, then, as Paul says, “We don’t need to work any more. Just print money”! While a humorous comment to be sure, at base it is deadly serious and, together with Krugman’s comment about the US not being “anywhere close to a red line”, represented the single most important topic of the debate. This is because, if the US finds it cannot finance itself at low rates, the entire discussion about whether or by how much to grow the debt becomes irrelevant, as it will be impossible. The US is more dependent on foreign financing than ever. Yet the US economy is on the weakest fundamental footing since the 1930s. It is also smaller as a share of global GDP than at any time since the early 20th century. It is thus understandable that many countries are already seeking alternatives to the dollar for international trade. The “red line” might be dangerously close. Indeed, I believe that it has already been crossed, unseen by the economic and policy mainstream, which also failed to see how signs of weakness in the US housing market were leading toward a huge financial crisis. WHERE KRUGMAN IS RIGHTTo understand where the (invisible) red line lies, we need to consider the one area where Krugman is correct: there is simply no way the US economy can grow from here without expanding the money supply and adding debt. Either the Fed keeps printing and the government keeps spending, or the economy will contract. That is the sober, unpleasant reality of the current starting point. And with the debt burden so enormously large, if the economy contracts, debt servicing costs will become prohibitive and eventually there will be a general, economy-wide debt default, public and private. Now there is minimal support in Washington for a general default, so it is rather obvious that the other road is going to be taken. The Fed will continue to print and the government will run deficits. However, while the economy will continue to grow in nominal terms, if only weakly, there is little in these policies to make it grow much if at all in real terms. Indeed, if the federal government’s share of the economy continues to grow at the expense of the private sector, then beyond a certain point, real growth will become impossible, as the public sector must tax the private in order to grow. But if the US economy cannot grow organically, then it is going to have to find this growth somewhere else. How is that going to work? Well, Krugman points out in the debate how Great Britain managed to pay down its colossal debts in the decades following WWII. But he neglected to mention how this was done: first, Britain devalued the pound by 30% in 1949. But even that wasn’t enough. In 1967, the UK devalued the pound by another 14%. In the early 1970s, the pound declined further. In 1975, the IMF (read: US, Germany, Japan) provided the UK with emergency lending assistance. So yes, Great Britain managed to reduce its debts as a share of GDP, but this was done overwhelmingly through resort to currency devaluation, with a bit of foreign generosity and even capital controls thrown in to boot. Is this what Krugman is advocating for today? That the US, the issuer of the world’s pre-eminent reserve currency, should just devalue and, if necessary, seek a bailout from its foreign creditors, including such friends as China and Russia? The idea is too absurd to contemplate. There is just no way that a reserve currency can remain so when the issuer resorts to devaluation and seeks bail outs from its creditors. The dollar’s loss of reserve status is simply inevitable at this point. When financial markets begin to understand that something is inevitable, what was regarded as a long-term risk is apt to become a short-term risk in short order, with obvious implications for interest and exchange rates and asset valuations generally. Krugman’s red line already has been crossed. The question now is how long it takes for financial markets to notice. Naturally, those investors that notice sooner, rather than later, and take appropriate action, stand a chance to protect their wealth through the turbulent times ahead. TO INVEST OR TO INSURE?Other factors equal, the greater the perceived uncertainty, the greater the demand for insurance relative to investment or, looked at slightly differently, the greater the preference for ‘defensive’ over ‘offensive’ investment styles. As more and more investors come to recognise that the red line described above has indeed already been crossed, the ‘price’ of insurance should rise relative to the ‘price’ of productive assets and defensive investment styles should outperform offensive. What appears straightforward at first glance is, however, anything but. Cash and government bonds are not a valid form of insurance in a world in which their supply is growing exponentially relative to the underlying productive potential of economies, including that of the US, the provider of the reserve currency and of benchmark government bonds. In this world, insurance must take a different form. Consider the following: if you take out an insurance policy on your house in some nominal amount, but due to inflation that nominal amount declines relative to the value of your house, then you are going to need to take out more just to maintain the same level of real cover. Alternatively, if you take out insurance on your house, but when you call it in you discover the insurance company is insolvent and can’t pay out, then you overpaid for your insurance. The trick is to purchase insurance that protects against inflation on the one hand and default on the other. Real assets are the only providers of such insurance. Their prices may be volatile when denominated in fiat currency units, but if owned on an outright, unencumbered basis, they can neither be arbitrarily devalued, nor can they be defaulted on. They thus represent a form of financial insurance superior to that provided by the financial system itself, subject as it is to devaluation and default. Red-line investing really just comes down to finding ways to avoid the risks inherent in the current financial and monetary system. Income-generating assets are fine as long as their sources of income are not subject to material devaluation or default risk. Certain kinds of infrastructure come to mind. But beware when infrastructure is leveraged. A claim to a productive real asset may seem to provide a form of insurance, but if the company goes bankrupt, that asset is forfeit to the creditors. In that case, it is better to be a creditor than a shareholder.[5] In an important sense, money itself is credit. It represents a social claim on future consumption. It may bear no interest, as formal credit does, but it is a form of credit all the same. Today, central banks create fiat money as a liability on their balance sheet, holding assets against it, normally their government’s and other governments’ bonds. Real money, however, is not at the same time someone’s liability. It is not something that can be diluted or defaulted on. The world’s fiat currencies do not qualify as real money in this important sense. Precious metals do. They are relatively scarce, indeed finite, and are not subject to default. The gold bull market may look rather advanced to some. Silver has also done much catching up since 2009. But as with all prices, these must be evaluated in relative terms. Has the price of gold kept up with money supply growth? No. Has it kept up with the growth of government debt? No. Has it kept up with the declining US share of the global economy and accelerating shift away from the fiat dollar reserve standard? No. Has it kept up with the ongoing loss of trust and credibility in financial and monetary institutions? No. Has it kept up with the growing probability that the only way to restore trust and credibility in future will be for governments to re-link their currencies to gold explicity, in the form of a new global gold standard? That last bit may sound a bit far fetched to some, but when you begin to connect the dots, it becomes increasingly difficult to deny that the developments citied above do not, eventually, lead back to gold. That is the core contention of my new book, The Golden Revolution. * Editor’s note: yes, this is backwards, but the Americans seem to like it that way. [1] For a detailed description of Krugman’s Nobel prize-winning research, please see the Nobel website here. [2] Link: http://www.bloomberg.com/video/91689761/ [3] This speech can be found here. [4] The Fed controls only the narrow money supply directly, by adding or draining reserves. Broad money is created by the banks, when reserves are lent out. However, while the Fed cannot create broad money, it can force its contraction by draining reserves. So the Fed could have limited broad money growth in 2003-06. But it chose not to, ostensibly because the rate of consumer price inflation (CPI) was low. This then begs the question as to whether the Fed should be targeting CPI or targeting money and credit growth instead, a topic I address at length in my new book, The Golden Revolution (John Wiley and Sons, 2012). [5] For a thorough discussion of the risks of bankruptcy and how investors can take advantage of it, please see “Why Bankruptcy is the New Black”, The Amphora Report, April 2012. The link is here. This article was previously published in the May 3rd edition of The Amphora Report.
Paul Krugman is the high priest of Keynesianism and modern interventionism, of economic improvement through inflation and budget deficits. As such he is bête noir among us libertarians and Austrian School economists. What makes him so annoying is his unquestioning, reflexive and almost childlike enthusiasm for state intervention, even in the face of its obvious failure, and his apparent unwillingness to probe any deeper into the real causes of our present economic problems or to show any willingness to investigate the effectiveness or ineffectiveness of his particular medicine. His Keynesian convictions are presented as articles of faith that no intelligent person can seriously question. A Krugmanesque argument is always built on a number of assumptions that are beyond doubt: 1) Recessions, depressions and crises are the result of the unhampered market. We actually do not have to investigate if markets were really free when recessions occurred or what really were the specific causes of whatever threw the economy off track. When there is a recession, depression or crisis, there must have been too much of an uncontrolled market. 2) The Great Depression was caused by uncontrolled markets. 3) Recessions, depressions and crises are practically the result of one problem: a lack of aggregate demand. People, for whatever reason (and who cares about the reason; let’s not get hung up on those details) don’t spend enough. If everybody were to spend more, people would sell more. Problem solved. It is the role of government to get people spending again. This is done by printing money and causing inflation so that people spend the money rather than save it. Or by the government running up deficits and spending it on behalf of the stupid savers. 4) The Great Depression was solved by the government spending lots of money and the central bank printing lots of money. 5) This explains ALL economic problems. 6) If there are recessions, depressions and crises, they can all be solved by printing money and by deficit spending. 7) If after many rounds of money printing and deficit spending, there is still a recession, then only one conclusion is permissible: there was obviously not enough money printing and deficit spending. We need more of it. 8) If after another round of money printing and deficit spending we still have a recession, then….well, do you not get it? We obviously have NOT PRINTED ENOUGH MONEY and we are NOT ACCUMULATING ENOUGH DEBT! And, by the way, remember 7) above. Krugman is practising Keynesianism as a religion. The 8 commandments above are not to be questioned. Whoever questions them is not worthy of debate. Consequently, Krugman has turned down requests to debate people like Peter Schiff or Bob Murphy. Interestingly, he agreed to debate Ron Paul on TV. The link is here. I have to say that Ron Paul did not do as well as I had hoped he would. He did not sufficiently attack Krugman in my view, for the failure and ultimately disastrous consequences of his policy prescriptions. Krugman is the one who should be made to explain his policy recommendations and who has to answer the criticism that policies like the ones he is recommending got us into this mess in the first place and that his policy ideas have been implemented for years to no effect, at least no positive effect. Yet, Krugman succeeded in putting Paul on the defensive, something in which he was greatly helped by the following: while Krugman may be the most outstanding, unashamed and fundamentalist of the celebrity Keynesians, the attitudes of the general public, the other journalists and thus most of the TV viewers are predominantly shaped by Keynesianism as well, and this means that Krugman, more than Paul or any ‘Austrian’ debater, can rely on some sense of intellectual sympathy. Maybe the viewers don’t quite share the unquestioning dedication to the Faith, that Krugman epitomizes. Maybe they feel queasy about printing trillions of paper dollars and running trillion-dollar deficits. Of course, a true believer like Krugman will never allow himself such feelings. But in general, the public, too, believes that the free market (and greedy bankers) caused the financial crisis; that we need low interest rates and other government measures to stimulate the economy; and that inflation is really not our main concern. Krugman, I think, cleverly used these attitudes to present himself as the safe and rational choice, and Paul as the weirdo who wants to pour out the state-policy baby with the crisis bath water. Ron Paul started strongly by pointing out that Krugman’s policy is based on the idea that a bureaucratic elite can set interest rates and decide how much money should be created, and that this involves an arrogant and dangerous pretence of knowledge. Very good point. Immediately, the apostle Krugman raised his head. “You cannot get the state out of money.” “The Fed has to set interest rates.” “You cannot go back 150 years.” I think this is where Ron Paul should have dug in and put Krugman on the defensive: “Why not? There was no Fed before 1913. That the Fed made things more stable is your assumption. But is it true? People like you and Bernanke tell us that the gold standard was to blame for the Depression. In the run-up to the Depression we had a gold standard but we also had a Fed. How can you say that the gold standard was to blame and the Fed was ultimately the solution? “Dr. Krugman just said ‘history told us’. That is nonsense. History doesn’t tell us anything. You need theory to interpret history, and your theory is wrong. You assign blame for the depression according to your Keynesian theory. If that theory is wrong – and I think it is completely wrong – your interpretation of history is hopelessly wrong. “Dr. Krugman, we no longer live in the 1930s. Why is it that you are harking back to those days? Are we still solving the Great Depression? “Fact is that the monetary and economic institutions of America were shaped by people with your beliefs, Dr. Krugman. We have your system today. We have conducted and are conducting your policies. And, Dr. Krugman, do you really want to tell the American public that these policies and these institutions, such as the Fed, are working? “We have no gold standard. Since 1971, the Fed is entirely free to print as much money as it likes. That is your system, isn’t it? That is what you recommend. You say the Fed needs to keep interest rates low and print money to stimulate growth. That is what the Fed did in 1998 after LTCM and the Russia default, just as you recommended. That is what the Fed did again after the NASDAQ bubble burst and after 9/11 – surely, that was not an Austrian policy but a Keynesian one. It was straight out of your rule book, Dr. Krugman. You say the uninhibited market is to blame for the financial crisis. I say your policy is to blame. The mortgage bubble was blown by the ‘stimulus’ policy of the Fed – low interest rates and plenty of new bank reserves – between 2001 and 2005. That was your recommendation, right? And those of your Keynesian buddies, such as Paul McCulley at Pimco. “Since 2007, the Fed has been conducting your policy. So has the US government. You demanded monetary stimulus and you got it. The Fed created $2 trillion dollars out of thin air. Interest rates have been zero for years. The US government is conducting stimulus policy to the tune of $1 trillion plus, every year. Are you telling me these are not Keynesian policies? What is it, Austrian policy?! “What you are recommending has in fact been the guiding principle of global economic policy for years. What you are recommending is a systematic distortion of the marketplace. It is persistent price distortion. That is why we had an unsustainable housing boom. That is why we had a mortgage boom. That is why we had a financial industry boom. And whenever these artificial booms – that you create with your policy – falter, the American public has to pay the price. And what do you suggest then? More of the same. More cheap credit. More government debt. In the hope that you can generate another artificial boom for which a later generation will again have to pay the price. “Dr. Krugman, you just answered the question of this journalist about how much more debt we should accumulate, by saying maybe another 30 percent but that nobody can say for sure. I agree that nobody can say how much debt the system can still take. But tell us, why do you think that the next 30 percent of state debt will magically stimulate the economy and that these 30 percent will thus achieve what the previous 30 percent obviously failed to do. “Dr. Krugman, you have me worried here. And I think our viewers, too. The only response you have to the abject failure of your policies is that we should do more of them. Whatever Keynesian stimulus is being implemented and whatever money the Fed prints, all you ever say is that it is not enough. We need more. Has it ever occurred to you that maybe the problem is the policy itself? Maybe your medicine is making things worse and not better. “And something else worries me, Dr. Krugman. When do we ever stop printing money and borrowing? I think that you are stuck in a failed paradigm, a failed economic theory and a failed policy program. This has happened to scientists and politicians before. You cannot admit that failure. When you are confronted with the failure of modern central banking, of Keynesian stimulus and of moderate inflationism, your only answer is that nothing is wrong with any of it, it is just not implemented forcefully enough. Dr. Krugman, you remind me of a doctor who misdiagnosed the disease and prescribed the wrong medicine and who is now unwilling to look at the situation objectively. All you want to do is increase the dosage. “If the viewers really want to understand what is going on, they should not buy Krugman’s new book but go to the website of the Mises Institute and look for some excellent Austrian School literature, in particular anything written by Ludwig von Mises himself. But if you don’t have time to do this, maybe you should start by reading Paper Money Collapse.” Well, I guess this is how it could have unfolded. In the meantime, the debasement of paper money continues. This article was previously published at Paper Money Collapse. Last week, an Austrian-School economist, Robert Wenzel, gave a speech to the New York Federal Reserve, and separately Bloomberg hosted a television debate between Ron Paul, who is running for the Republican Presidential nomination, and Professor Paul Krugman, one of the foremost advocates of Keynesian economic policy. The debate between advocates of big government and small government is beginning to move into the media. It is not so much a question of who wins the debate: rather it is that the minority Austrian view is being noted by a few economists at the Fed, and that Krugman, who last year turned down an opportunity to debate economics with Robert Murphy of the Ludwig von Mises Institute in America, presumably felt more comfortable defending his interventionist beliefs against a politician than a trained economist. Whatever your opinion, the fact that some establishment economists are at least curious about Austrian economics and that Ron Paul is getting air-time for his views is a good thing, if only because it makes people aware there is an alternative to establishment economics. It seems that Wenzel’s invitation was in part because he had successfully forecast the housing crash, while the Fed’s economists had been unable to foresee it. In the Q&A that followed, one economist stated that before the Fed, there had been worse economic crashes. Putting aside the impossibility of ever establishing whether or not this is actually true, such crises as there were originated in either natural disasters, such as crop failures in an agricultural-based economy, or the expansion of bank credit fuelling speculative bubbles. Today crop failures do not have the same impact, but fluctuating levels of bank credit certainly do and are a key factor behind the accumulation of debt. Ron Paul’s debate with Krugman received more attention than Wenzel’s speech, given that it was televised. Their debating techniques differed, with Paul sticking to facts, emphasising the unproductive cost of big government and the Fed’s destruction of savings through monetary expansion. Krugman put forward his beliefs, based on his version of history, which we were required to accept without question. The problem with history is that analysis of it is always subjective. Canute apparently sat on his throne on the beach, and commanded the tide to recede. Did he do this because he believed he was a demi-god who could command the elements, of did he wish to show his admiring subjects that he wasn’t all-powerful? Both views are valid depending on the position the historian takes, and that is the weakness of any historical analysis. There is nothing new in this. Carl Menger – the founder of the Austrian School – came up against the German Historical School, which relied on a subjective interpretation of Prussian history for economic policy. It was this school that derisively termed Menger’s school as provincial, or Austrian. Not much has changed in economic debating techniques. But please note that Austrian economics, which argues from a strong and well-reasoned theoretical analysis of human action, still endures and is enjoying a revival. The Historical School is now a footnote in history, as surely as Keynesianism will be one day. This article was previously published at GoldMoney.com. In the past year we have witnessed the growing influence and clout of the Occupy Wall Street movement in the States, the St. Paul’s protestors, or any other of the numerous regional protests spreading around the developed world. Although at times difficult to pinpoint exactly what has gotten these groups so upset – whether lack of jobs, austerity cuts, or the like – there does appear to be one common concern. The growing divide between the “rich” and the “poor” seems to be increasing, and this is causing alarm. In most cases of economic advance we have seen a growing divide between the haves and the have-nots. This makes sense for many reasons. In a market economy one ends up having much by providing others with much. It is only by ensuring that others’ needs are best met that the businessman can attract clients. On another level, we should not forget that just because there is a growing divide between two tiers in society, that does not imply that both are not better off as a result. We can think back to Margaret Thatcher’s final speech in parliament when the Right Honourable Gentleman opposite chastised her government for just such a growing divide. Thatcher’s response was fitting as an end to her terms as Prime Minister, but also to the Britons whose lives were made better under it – even though several British citizens had gotten wealthy (even fabulously so) under her tenure, the average Briton had also seen their quality of life improve immensely. Indeed, it was probably those at the lowest echelon of society – the destitute with no jobs in the 1970s – that benefited the most as their lives gained new meaning in the booming 1980s. Today’s divide is different, however. The rich are getting richer and there is no discernible improvement in the life of the average Briton. Indeed, inflation adjusted salaries are lower than they have been in a decade. Instead of the rich spending their largess on investment that improves the lives of the rest, they are spending it on what many see as superfluous luxuries. In 2010, Sotheby’s London set a new auction record with the £65m sale of Giacometti’s “L’Homme qui Marche 1”. While many housing markets remain in tatters, mega-mansions are doing fine. During the peak of the boom in 2007, the highest price paid for a home outside of London was outside of Henley-on-Thames. The selling price was £40m. Last autumn the same house sold for £140m. The Knight Frank Wealth Report reports that 25 percent more high net worth individuals are expressing an interest in fine art in 2011 than the previous year. These ostentatious displays of wealth are sure to evoke feelings of insecurity and ire from the have-nots. They are purchases that only a small fraction of the population can afford, and benefit from. The difference in the wealth divide that exists today compared to its 1980s has a simple explanation. They are caused by different conditions. Take a sustainable economic advancement. The business setting improves, taxes are lowered and regulations done away with (or made more sensible) and conditions of low price inflation allow for easy monetary calculation. Businessmen follow their natural urge to serve wants better than others in hopes of earning a monetary gain. If they do this well and customers demand their products, these businessmen hire additional workers. Everyone wins – the business leaders get remunerated for their foresight and hard work with wealth, workers get jobs, and customers gain access to new goods. Each worker sees his wealth increase due to a new or better job. The businessman gains even more – he earns additional money from each and every one of these additional workers he hires (or else he would not have hired them in the first place). A wealth divide emerges, but all involved are better off than they otherwise would be. That story more or less explains the growing wealth divide that defined Britain’s 1980s. Today’s wealth divide is different. Business conditions are not improving. Taxes are not being lowered, a condition that would incentivize more entrepreneurs to start enterprises. Regulations are not easing to remove barriers to entry for smaller firms – those typically lacking the legal budgets to navigate such difficult waters. Price inflation is not exactly low, and is also highly uncertain. None of the criteria for a booming economy, one capable of causing a beneficial wealth divide, are apparent. Yet a growing wealth divide we have. One explanation is the final criteria above – the lack of low and stable price inflation. When new money enters the economy, it does not affect all participants equally. It enters at a specific point where someone spends it. At that moment, the constellation of prices reflects an old quantity of money and spending patterns. Once this new money enters the economy, price pressure increases. The first person to spend this money benefits as they spend money which then causes prices to adjust – they can take advantage of the situation by being part of the cause of the price increase, instead of an innocent bystander. Price inflation is not something that drives business growth. It aids some (those who first receive the money), but it complicates life for the rest of us. Each year that passes we see prices increase. They do not all do so evenly. We need to decide how best to allocate our money among the new array of prices. Those who first spend any new money are not encumbered in the same way – they are the ones that make prices increase. Since this crisis has began, the Bank of England has embarked on a highly inflationary policy aimed at rescuing insolvent banks and aiding those nearly so. This policy has evidently not promoted economic growth in the economy. It has also advantaged those few that have early access to the funds created and have the liberty to spend them at the old pre-inflation prices. Investment managers, developers, bankers and the like – those closely involved in the process of injecting new money into the economy – have been spending the increased supply of pound notes on art, real estate and fine wines. While this gives an impression of wealth to some, it is all an illusion. It is a monetary manipulation enriching some at the expense of others. For the rest of us – those feeling as though we are falling behind the Joneses – the object of our ire should not be those that are getting wealthy at our expense. I would do the same thing if I was in a position to receive new pounds that Mervyn King is gifting around. I would direct my ire at the root cause instead. The Bank of England’s inflationary policies since 2007 (and before) have created a special class within Britain. Members of this class get to use money to fund their consumption at old pre-inflation prices. For the rest of us, well, we get the feeling that we’re left behind. An interesting upcoming event …
In the slump of a cycle, businesses that were thriving come to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs. Businessmen themselves are confused as to why. They cannot make sense of why certain business practices that were profitable yesterday are losing money today. Bad business conditions emerge when least expected — just when all businesses are holding the view that a new age of steady and rapid progress has emerged. In his writings, Ludwig von Mises argued against the prevailing explanation of the business cycle by overproduction and under-consumption theories, and he critically addressed various theories that depended on vague notions of mass psychology and irregular shocks. In the psychological explanation, an increase in people’s confidence regarding future business conditions gives rise to an economic boom. Conversely, a sudden fall in confidence sets in motion business stagnation. Now, there can be no doubt that during a recession people are less confident about the future than during good times. But to observe this is not to explain it. Likewise theories that view various shocks and disruptions as the central cause behind boom-bust cycles do not advance our knowledge regarding the boom-bust cycle phenomenon. Neither explains how the boom and bust come about, or why they are of a recurrent nature. To arrive at a correct explanation Mises held, we need to trace the change in business conditions back to previously established and identified phenomena, and that is precisely what these theories do not do. Hence Mises concluded that all these theories do not provide an explanation but rather describe the phenomenon in a different way. Mises also held that various statistical and mathematical methods are another way of describing but not explaining events. Statistical methods make it possible to generate charts of data fluctuations but they do not improve on our knowledge of what causes the fluctuations.
The Circulation Credit Theory of Business Cycles Mises made a distinction between credit that is backed by savings, and credit that does not have any backing. The first type of credit he labelled commodity credit. The second he labelled circulation credit. It is circulation credit that plays the key role in setting the boom-bust cycle process. Consider a producer of consumer goods who consumes part of his produce while saving the rest. In the market economy, our producer could exchange the saved goods for money. The money that he receives can be seen as a receipt as it were for the goods produced and saved. The receipt is his claim on the goods. He can then make a decision to lend the money to another producer through the mediation of a bank. By lending the money of the original saver, the lender transfers his claims on real savings to the borrower. The borrower can now use the money — i.e., the claims — and secure consumer goods that will support him while he is engaged in the production of other goods (say, tools and machinery). The credit in this case is fully backed by savings and permits the expansion of tools and machinery. With better infrastructure, it is now possible to produce not only more goods but goods of a better quality. The expansion of real wealth is now possible. Once a lender lends his money, he relinquishes his claims on real goods for the duration of the loan. In an unhampered market economy, borrowers are users of savings who make sure that savings are employed in the most efficient way: generating profits. This means that real savings are employed in accordance with consumers’ most important priorities. We can thus see here that as long as banks facilitate commodity credit, they should be seen as the agents of wealth generation. In contrast, whenever banks embark on the lending of circulation credit they in fact become the agents of real wealth destruction. As opposed to commodity credit, circulation credit is not supported by any real saving. This type of credit is just an empty claim created by banks. In the case of commodity credit, the borrower secures goods that were produced and saved for him. This is, however, not the case with respect to the circulation credit. No goods were produced and saved here. Once the borrower uses the unbacked claims, it is at the expense of the holders of fully backed claims. In this way, circulation credit undermines the true wealth generators. Now, as a result of an increase in the supply of circulation credit, money market interest rates fall below the natural rate, that is, the rate that would be established by supply and demand if real goods were loaned directly in barter without the use of money. (In his later articles, Mises referred to the natural rate as the rate that would be established in a free market.) As a result of the artificial lowering of interest rates, businesses undertake various new capital projects to expand and lengthen the production structure. Prior to the lowering of interest rates, these capital projects didn’t appear to be profitable. Now, however, as money market rates are kept below the natural rate, economic activity zooms ahead and an economic boom emerges. Such a situation cannot last. Mises here explains the important role played by the subsistence fund. The expansion of the production structure is always constrained by the availability of the means of sustenance (saved consumer goods) to maintain workers during the period of the expansion and the enhancement of the production structure. The forced lowering of interest rates bring into being production processes that would not otherwise be undertaken. A production structure is now created that produces goods and services that consumers in fact cannot afford. Instead of using the limited pool of the means of sustenance to make tools and machinery that will generate consumer goods on the highest individual priority list, the means of sustenance are wasted on capital goods that are geared towards the production of low-priority consumer goods. At some point, the producers of such goods will discover that they cannot make a profit or even complete their plans. What we have here is not over-investment but misdirected investment or mal-investment. The expansion of the production structure takes time and the limited subsistence fund may not be sufficient to support the expansion of the capital structure. If the new flow of the production of consumer goods does not emerge quickly enough to replace the currently consumed consumer goods, the subsistence fund comes under pressure. At some point in time, banks discover that marginal businesses are starting to under-perform. This causes them to slow-down the expansion of circulation credit, which in turn puts an upward pressure on interest rates. As a result this starts to undermine various other business activities (non marginal), and can often be the precipitating event that leads to an economic bust. Mises wrote that the bust phase of the business cycle process could be precipitated by other events. The expansion in the money supply enriches the early receivers of money. Those individuals who have now become wealthier as a result of receiving the money may alter their pattern of consumption. This may force businesses to adjust to this new setup. Once the rate of expansion in money slows down or comes to a halt, the new pattern of consumption cannot be supported and the new capital structure that was erected becomes unprofitable and must be abandoned. It is not surprising that Mises was strongly opposed to the idea that central banks should impose “low” interest rates during a recession in order to keep the economy going. Instead, he believed that the policy makers should not engage in the artificial lowering of interest rates but rather refrain from any attempts to manage the economy via monetary policy. By curtailing its interference with businesses, the central bank provides breathing space to wealth generators and thereby lays the foundation for a durable economic recovery. A version of this article was previously published at Mises.org.
It was quite fitting that in a week that saw Britain slide into its first double-dip recession since 1975 we also saw evidence – notably from the political left – of the sort of insular bigotry and protectionist narrow-mindedness that one associates with that ugly decade. And if there was any doubt about the longevity of the UK’s fragile Con-Dem coalition, its honeymoon period is certainly over now. Nor were the signs of some kind of political unravelling confined to British shores. French voters in the presidential elections shocked markets by a) favouring the socialist Francois Hollande and b) giving almost a fifth of their votes to the far-right extremist Marine Le Pen. In another turn of the sovereign debt screw, Spain was downgraded toward reality. The Dutch government, meanwhile, collapsed altogether. Amazingly, the people of Europe just don’t seem that keen on austerity. Richard Lambert for the FT anticipated Barry Sheerman’s nastier musings by a week, in a piece entitled ‘Why no British staff at Pret A Manger?‘ Part of his answer:
This conclusion was supported by a subsequent letter to the paper’s editor from Tony Constance of Akramatic Engineering in Derbyshire:
Not to be outdone, another journal of repute noted the case of Carl Cooper, who hired seven new recruits to his marketing firm in Hersden, Kent, only to find that none of them turned up to work; four of them failed to show because of the rain. Perhaps this outbreak of workshyness is what happens after a champagne socialist administration urges half the school population towards university irrespective of any merit or underlying interest. As our disaffected youth are apparently prone to remark: whatever. Martin Spring’s latest ‘On Target’ newsletter (‘Britain: a culture hostile to growth’) separately contains a devastating blow-by-blow analysis of the difficulties facing Messrs Cameron and Osborne, and it is difficult to disagree with his suggestion that
As Enoch Powell said, all political lives (unless cut off midstream at a happy juncture) end in failure, because that is the nature of politics and human affairs. The political life of the current coalition may end up being remarkable only for its brevity. Chris Dillow quite reasonably asks why the recession of today hasn’t produced the sense of crisis manifest in the 1970s. His answer: that average real wages are much higher now so although standards of living are falling, they’re falling from a much higher level that softens much of the pain (of the austerity that hasn’t even really arrived yet). And that the working class is more atomized now, both geographically and ideologically. It may also be that back then the young by and large wanted to work and couldn’t, and now by and large don’t even want to, if the examples of Akramatic Engineering and Carl Cooper’s Car Smart are anything to go by. But there is one outcome from the 1970s that is genuinely to be feared and it is called stagflation, the risk of which seems to be rising every day, if it has not indeed already arrived. Stagflation is and will be the natural side effect of extended QE during a period of widespread deleveraging – the printing of money that nobody wants. An outbreak of serious stagflation will also more than decimate conventionally managed debt and equity portfolios. But we live in strange times – times, for example, that reward bankers handsomely for bankrupting the economy. So the likes of the FT’s Chris Giles can insist with impunity that ‘The Bank of England must unleash more QE’ (26 April) without a scintilla of justification or any substantive evidence that it works. In a letter to the paper’s editor from the same day, economist Roger Alford remarked that
Being hidebound by the intellectual constraints of his faux science “profession”, Mr. Alford does not take this argument to its logical conclusion – if the institution is so difficult to govern and the role so difficult to effect, why have it in the first place? We know why the Bank of England exists – to protect the banking system at all costs (including that of bankrupting the productive economy and the taxpayer), and to finance the government’s debts (the same point repeats). But ever more urgent austerity and an insoluble sovereign debt crisis are uneasy bedfellows. By definition we cannot shrink our way back to the sort of growth required to service the West’s accumulated debts. Something has to give. That something will ultimately be social disorder on a continent-wide basis, not least as an ever more put-upon taxpayer base is obliged to fund the increasingly untenable costs of Big Government. Out of that disorder perhaps will come genuine political leadership and the retrenchment, rather than the constant advancement, of the leviathan state. If that is what it takes to shift an unsustainable status quo in which vampire banks and clueless bureaucrats suck the life out of the productive economy, bring it on. “The last thing that the markets need right now is increased political uncertainty at the heart of Europe at a time when the economic outlook is already bleak,” commented Capital Economics. To which the only reasonable response is: tough. Strange times and fundamentally distorted markets (see QE, again) require investors to possess unusual psychological fortitude. Two things are required to maximise the probability of meaningful capital growth or simply capital preservation in real terms within such a perilous environment. One of them is an attractive valuation at the inception of an investment. Pockets of value undoubtedly persist throughout debt and equity markets, though one may have to look harder than normal to identify them. (We leave momentum investing to others.) The other is patience. An easy philosophy to articulate, but a fiendishly difficult path to follow. This article was previously published at The price of everything. |
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