|
|
By Anthony J. Evans, on 16 November 11
I think this is a complicated question to answer, and both sides of the debate have a tendency to over simplify.
If we understand the goal of QE to be an increase in aggregate demand such that the Bank of England’s implicit and explicit objectives are met, I think it’s reasonable to conclude that it worked “better” than its critics feared, but not as well as its advocates hoped. In other words, I think output is higher than it would have been without QE, inflation is lower than some people warned, but the former is lower than and the latter higher than the MPC would like.
In this week’s column for City AM I wanted to highlight an irony in the debate. If “above target inflation makes little difference if expectations remain anchored” one possible explanation of the muted effects of QE is the Bank’s decision to retain an inflation target. Therefore:
We now have the odd situation where those warning of impending hyperinflation – the sternest critics of QE – provide the intellectual prerequisites for it to work. By contrast, in pandering to those concerns, its proponents ensure that it will not.
It strikes me that unless the Bank of England allows inflation expectations to rise, QE will have a muted effect.
Read the whole article here.
By Sean Corrigan, on 10 October 11
Since the Great Financial Crisis started (in truth, since well before), we have unwaveringly maintained three main tenets in relation to how one should deal with the aftermath of a credit-driven, mass misallocation of resources.
Firstly, we have said that, even if we did accept, arguendo, the trite macroeconomic mumbo-jumbo of over-aggregation, that tired old, maintenance-of-spending-at-any-cost, Keynesian game of trying to compensate for the overstretch of one particular ‘sector’ of the economy by passing ‘the bad, or depreciating, half crown to the other fellow’ is most likely to tangle us in an inextricable knot of surindebtedness if the ‘fellow’ is a governmental body. We say this, since the specious initial advantage of the state’s temporary ability to ignore the imperatives of accounting logic is doomed to be overwhelmed by the legal intractability associated with that same entity’s eventual financial exhaustion. Furthermore, this mere procedural failing is always horribly compounded by the dilution of the sense of direct responsibility which accompanies its involvement in any plight in which the relevant country lands itself.
Secondly, we have stood foursquare behind the idea that all the losses are actually incurred during the heady euphoria of the Boom, that the Bust is nothing more than the overdue recognition of those mistakes, and that to procrastinate thereafter in their acknowledgement is not to avoid the pain, but to exacerbate it in much the same way as a sufferer from a cancer can do himself nothing but harm by trying to delay the awfulness of the therapy which sadly must await him.
Thirdly, it has been our avowed belief that, contrary to the accepted wisdom, there are very few useful macro solutions to such a condition, but only micro ones; that recovery is built one job, one company at a time, from the bottom up.
Therefore, the most beneficial role for Leviathan is not some crazed, Frankenstein process of pulling levers and administering potions in some swivel-eyed, Gene Wilder fashion, but is one of expediting the renegotiation of now-unfulfillable contracts; of impartially overseeing a just transfer of assets from the failed to the well-founded; and of ensuring as few scarce resources as possible—in this time of unexpected penury—are pre-empted by the dead hand of the bureaucracy and, hence, are made available to the putative builders of a new, more prosperous tomorrow.
In all of this, we have been generally cynical of the ability of politicians to deny themselves the chance to carve their effigy on an imaginary Mt Rushmore of interventionists. We have been even more deprecatory of the nomenklatura of would-be Plato’s who advise them, those ’socialists of the chair’ who blindly fill their pink column inches with the ludicrous argument that the only remedy for the failure of government interference is more interference. We have been vehemently opposed to the machinations of central bankers—the ultimate succourers, when not the original seeders, of the Boom—who continue to frame every response in terms of the provision of liquidity to their precious cartel of institutionally parasitic, fractional reserve banks.
Despite this, it has been hard to suppress the faint fluttering of a hope lately freed from its hard chrysalis of doubt by the integrity of some members of the northern European political class and their nominees within the Heart of Darkness of the central bank itself.
Germany—with both tacit and expressed support from among the Dutch, the Finns, the Slovaks, and others—has wrestled itself close enough to doing the right thing—to writing off much of the debt; to making the imprudent private owners and creditors face their responsibilities; and to insisting on guarantees of future good housekeeping from the incontinent debtors—to merit our applause, even if its courage eventually does fail it, or the temptation to take the road to hell along which everyone else is frantically pointing finally does prove too hard to resist.
However, any sense of the victory we entertain in this critical war of ideas—albeit four years late and several trillion dollars short—has to be tempered greatly by the awful truth that two of the major central banks have already succumbed, once more, to their liquidity fetish, while a third is patently ravening for the chance to overcome the present domestic impediments to further action.
One of them, the ECB, is slowly transforming itself into a Fed—over the careers of ex-Bundesbankers perhaps, but nonetheless inexorably so.
Believe, if you will, that all such measures as those announced this week are ‘temporary’—only to be countenanced for the duration of the emergency—and, as our New York friends say, I have a bridge to sell you in Brooklyn.
Yes, it is true that interbank lending has frozen, that the vast apparatus of sovereign finance is creaking alarmingly, and that real money supply growth in the Zone is hovering just above the zero bound. Of these, however, only the third is a potentially justifiable field for central bank intervention in extremis.
The first is a consequence of the long-suppressed mistrust of one another’s balance sheets being expressed by the banks themselves; a fear which could be dispelled overnight if they would each do no more than is required of any public corporation, namely, to produce an honest set of accounts, even if this would be to undertake an exercise in triage—of the merciless sorting of the weak from the strong. To recognise its origin is already to point to where the cure may be found—extended repo operations and expanded bond purchases do not lie along that way.
The second handicap is the legacy of long years of populist vote-buying whereby venal politicians have far too liberally dispensed a morally corrupting patronage, not by having to undertake the invidious task of clearly identifying the winning net recipients of tax monies from the losing net payers standing beside them at the hustings, but by recourse to the seemingly painless expedient of borrowing funds which are never intended to be repaid and which are, in great part, the result of inflationary credit creation on the part of the same central and commercial banks who are now so threatened by the fall of all these democratic Bourbons. Again, to make this diagnosis is to indicate what form the remedy must take and to show that the prostitution of the central bank, so as to maintain the status quo ante, will prove futile, if not fatal, to the patient
As for the Bank of England—well, yes again, real money supply has been running at a negative rate in the UK for some good few months past, dragging activity lower as it has. Yet a very good part of this real contraction is because the Bank has also managed to ignite a nasty rise in prices in violation of its rather open-ended mandate to moderate these over a self-determined and highly elastic ‘medium-term’.
As we have said before, the fact that the UK still manages to run a near-record trade deficit amid a severe recession and during an ostensible private sector credit crunch, despite a 25% drop in sterling’s real effective exchange rate such as to take it to a level only matched during the IMF crisis of the mid-70s Labour administration, is testimony both to the fact that the overall squeeze is not so intense as it seems and to the failure of all this macro-meddling to restore a semblance of competitiveness to a hollowed-out nation.
Where the leakage occurs, of course, is in the realm of the state where, for all the gnashing of teeth and tearing of hair about the ‘austerity’ programme, spending continues to rise, with the change in the state component of expenditures in Q2 outstripping that of households for the fifth quarter out of the last six. Total state outlays are still making new record highs, both outright and as a proportion of non-state GDP—that latter ratio now bumping up against the 60% mark, no less.
So it is all very well for Mervyn King to bleat about facing the most severe financial crisis since the 1930s, or to casually dismiss the cries of the thrifty that their livelihoods are being crushed in the vice of rising prices and falling returns to capital, but it is he and his predecessors, together with the political masters they serve, who have led us into these straits, by dint of their unshrinking embrace of a perverted orthodoxy of inflationary entitlement—of the entitlement of welfare recipients to their doles, of office-seekers to their votes, and of inveterate financial gamblers to their place at the tables of the state-sponsored, state-regulated, and state-underwritten casino.
Mr. King’s response to all this? Why, again to make it easy for the state to spend more and difficult for many of the most vulnerable elements of the nation to spend as much. Bravo, indeed!
So, while Chairman Bernanke can, for now, only threaten to increase the disruption he causes to the market’s pricing signals and to its ability to allocate resources optimally over time, his peers are already at work doing much the same mischief.
Caught up with the demands of their real dual mandate—that of keeping the ruling class happy while looking after the interests of their cabal of big bankers—few of them will stop to listen to what businessmen are telling them, though the message is being broadcast in the most clarion of tones.
Take the most recent Duke University/CFO Magazine quarterly survey of senior US executives as a case in point.
Asked to list external concerns in order of importance, the perennial question of sufficient demand for the firm’s products came top, but a clear second place was secured by the category ‘Federal Government agenda/policies’ – aka, REGIME UNCERTAINTY!
As for internal worries, the ability to maintain margins was top, the cost of health care, second, and the ability to forecast, third—over to you, Mssrs Bernanke and Obama, once more, for creating and fostering such extreme REGIME and MARKET UNCERTAINTY!
And the result of all this? Exactly what we showed in graphical form and briefly discussed in our last edition:-
A third of CFOs say they will not deploy excess cash this year, because they want to retain it should credit markets tighten. Twenty-nine percent say they are hoarding cash due to economic uncertainty, and 31% say they don’t have any excess cash to spend.
More worrying still for all those executives and traders who keep telling us that while business in the Old World may be slow, Asia will keep firing away and so save their bacon, the separate respondents from that particular region also manifested an uncharacteristically subdued tenor. We quote as follows:-
Optimism about the regional economy in Asia (not counting China) fell, with optimists and pessimists now evenly balanced. Last quarter, optimists outnumbered pessimists by two to one. In China, 69 percent of firms have grown more pessimistic about the economic outlook.
The top internal concern among Asian CFOs is difficulty in planning due to extreme uncertainty, working capital management and employee morale. The top external concerns in Asia are global financial instability, intense pricing pressure and weak consumer demand. Chinese CFOs also worry about government policies.
QED
But, carry on regardless! The present approach has been so successful that while one in ten Americans with a full-time job lost it in the slump, barely one in six of those unfortunates has found similar work since, leaving the total at 2000 levels and its fraction of the population at 1975 and 1983 recessionary depths, despite the intervening incorporation of women into the workforce. As for manufacturing—supposedly doing well on the cheapest dollar of the modern era—almost one quarter of the hours worked here were lost from the local maximum of 2006, of which, again, less than a sixth have since been replaced, leaving total hours fully a third below the stationary average of 1984-2001, and still stuck where they were in St. Roosevelt’s bleak 1940s!
Meanwhile, the 3mma of US NAPM new orders has dipped below the 50 watershed for the first time since the crisis, an event which has historically signalled a further deterioration over the succeeding six months in 70% of cases, and an ill omen we must interpret in light of the fact that the magnitude of the last few months’ fall in this component has only been exceeded three times in the past century—in 1974/5, 1980, and in 2009 itself.
Even in Germany, 2009-10’s impressive growth in factory orders has begun to peter out to the point that there has been little further sustained growth so far this year. Meanwhile, at the other end of the world, a PMI of Korean orders languishes at a 2-year low, while exports of capital goods from Taiwan have not been this weak since early 2010.
It may be too much to say that the wheels are coming off the recovery, but they are certainly beginning to wobble.
By Toby Baxendale, on 6 October 11
As we feared, the wise men at the Bank of England have decided that what our ailing economy needs is another dose of QE.
I was about to blog the event, but it’s hard to match the eloquence of Daniel Hannan’s latest post:
According to the BBC, the Bank of England has decided to ‘inject a further £75 billion into the economy’. Who knew it was that easy? I mean, why not inject £500 billion? Or a trillion? According to the BBC’s logic, it would surely make us the wealthiest nation on Earth.
I can’t believe I’m having to write this, but nothing new will be manufactured, invented or developed as the result of this monetary splurge, no services offered, no businesses founded. Rather, the money already in circulation – the money in your bank account, in your purse, under your mattress – will be worth less. The government, in other words, is helping itself to your savings – and, in doing so, is damaging productivity, disincentivising work and weakening the competitiveness of the British economy.
These themes will be familiar to regular Cobden Centre readers, as will his conclusion:
It’s a paradox. If I were to print counterfeit £20 notes and buy goods with them, I’d be perpetrating a fraud: I’d be buying something of real value with something I had magicked out of thin air. Yet when a central bank does the same thing, the half-educated economists who dominate our universities and television stations nod approvingly and mumble cliches about ‘boosting demand’.
You can’t keep boosting demand without producing anything, for Heaven’s sake. That’s what got us into this mess.
We’ll post more on this latest act of folly in due course, but in the meantime Steve Baker has posted a warning straight from Human Action:
By Mark Goodhand, on 2 September 11
In his latest article for ConservativeHome, Steve Baker considers the viability of America’s central bank:
A review of the US Federal Reserve’s own document: “FEDERAL RESERVE statistical release, H.4.1: Factors Affecting Reserve Balances of Depository Institutions and
Condition Statement of Federal Reserve Banks”, issued on August 23rd 2011, reveals some interesting information about the state of the Federal Reserve, the US central bank: it’s very nearly bust. As it is indirectly the lynchpin of the global financial system, that matters to the UK.
The size of the Fed’s balance sheet is now about $2,843 billion, up from about $800 billion three years ago. The huge increase in the Fed’s balance sheet stems from bailouts, quantitative easing, and other central bank “liquidity” operations.
…
The Fed’s capital base is $71 billion. That represents about 2.5% of its assets, or a leverage ratio of 40 times its capital. This ratio would have been considered unthinkable prior to the crisis: it is about four times greater than that permitted by the new Basel proposed rules for commercial banks and simply demonstrates that the bailout format and quantitative easing do not make these problems go away. If the patient has been incorrectly diagnosed, taking the wrong medicine will not cure him.
This capital to asset ratio means that a loss on its assets of 2.5% would be enough to make the Fed, by any normal standard, insolvent – unable to pay its debts.
Read the entire article to find out just how likely this is.
By Detlev Schlichter, on 17 May 11
According to the mainstream press, the reason behind the present sell-off in commodities – and in many so-called ‘risk-assets’ (stupid really, all assets are risky) – is weak growth, not tighter monetary policy. At least this is how I interpret the market commentary in the Financial Times and the Wall Street Journal. The mainstream media often gets it wrong – but let’s assume for a minute that they are right. What does it mean?
Super-easy money was supposed to ‘stimulate’ us into recovery. In fact, it is causing input prices to rise, which in turn squeezes profit margins and chokes off the recovery that easy money was supposed to bring. Now the faltering recovery in turn undermines commodity prices.
Again, we see that, two years after the US recession officially ended, nothing has been solved. Our problems are still with us. In the meantime, the trade-off between growth (even growth of the artificial and therefore short-term type) and inflation is getting progressively worse. The UK offers a powerful illustration of this: again the Bank of England had to revise inflation up and growth down. Her zero-interest rate policy is boosting prices with little lasting effect on growth. It goes to show that once your economy is out of whack because of distorted prices and misallocations of capital as a consequence of previous money injections and excessive indebtedness, you can’t easily get out of this mess by printing more money and keeping rates artificially low for even longer. Bottom-line: the global economy is still very weak. The ‘recovery’ is feeble or non-existent.
Commodities are now correcting because there was too much hot money in them, or because they ran too much ahead of other prices in this mega-trend of inflation that we now entered, thus undermining demand for them.
If this were purely a commodity phenomenon, equities should rally. Lower commodity prices mean lower input prices and higher profit margins. However, equities are presently correcting as well. This is further indication that what is behind this move is concern about the recovery. If that is true, and if it lasts, we won’t see the monetary tightening that is now being talked about. Instead we may see more easing – and then commodities will rally again.
Last week, Trichet already forgot to mention ‘vigilance’ in one of his speeches. If unemployment stays high in the US, and the equity market comes under pressure again, it is only a question of time until we get QE3. Remember, The Bernanke made it his declared goal to boost the economy via high asset prices, including equity prices, thus benefiting Wall Street and the upper echelons of US society whose paper gains would then trickle down to the regular folks – he may have put it somewhat differently. In any case, if the economy is weak, we will get more monetary stimulus – and thus higher commodity prices, in particular a higher gold price.
Continue reading at Paper Money Collapse.
By Gordon Kerr, on 27 April 11
Gold reaches £913 per ounce
If political leaders and central bankers think that they can curb the currency debasing effect of QE merely by turning off the tap, they are mistaken. Markets reflect not just today’s monetary policies but also rational players’ expectations as to future activity.
At a lunch recently with Ewen Stewart, the parallels between the UK’s QE and the Weimar Republic’s printing of paper Reichsmarks became starkly apparent. Since QE began, Ewen explained, 69% of all gilt issuance has been bought by the Bank of England. This makes sense when one digests the transactions entered into by the Government to create money and then issue gilts. Consider the following transactional steps:
- The UK Treasury’s Debt Management Office announces its intention of buying specified financial assets, either gilts or bank loans;
- Life funds and other institutions willingly compete in this ‘buy back’ auction to sell gilts and other ‘high quality’ assets to the DMO, and prices are moving in favour of the seller given the DMO’s initiative;
- The Bank of England presses a button on a computer and transfers the newly printed cash to the DMO in order to settle the buy back trades. The DMO credits the accounts of sellers with the newly created money;
- The DMO subsequently announces a conventional gilt auction whereby gilts are issued by the DMO for purchase by banks.
What are the commercial drivers of these four steps? Why would the DMO issue at Step 4 given that it has purchased at Step 1? The only conclusion is the creation of money, which necessarily entails the debasement of the currency.
Would the DMO agree with this summary? Perhaps not. It explains the QE operation in different language. According to its pamphlet “Quantitative Easing Explained”, the exercise stimulates the wider economy by ‘injecting’ money.
The MPC’s decision to inject money directly into the economy does not involve printing more banknotes. Instead, the Bank buys assets from private sector institutions – that could be insurance companies, pension funds, banks or non-financial firms – and credits the seller’s bank account. So the seller has more money in their bank account, while their bank holds a corresponding claim against the Bank of England (known as reserves). The end result is more money out in the wider economy
But this denial that banknotes are being printed is mere spin. The term ‘injection’ is misleading – it implies that the substance being injected is already in existence. This is not the case with QE. A pamphlet purporting to explain QE should clearly state that the money is “created” before being injected. It is true that banknotes are not actually physically printed as they were in Germany in the 1920s. But that is because today, unlike in the 1920s, bank accounts are represented by computer entries. Therefore it follows that the creation QE and the transfer of QE proceeds to a bank by increasing the bank’s account balance with the Bank of England is, in plain English, printing money. It is an exact modern equivalent of rolling the printing presses and sending a pile of banknotes round to the physical headquarters of RBS or Barclays under the watchful eye of a bevy of burly bank stewards.
Indeed, the sophistry of the DMO’s denial that QE is money printing, based on the technical point that physical ink and pieces of paper are not required at the point of QE money creation, is exposed by the diagram summarising the above quoted paragraph from page 8 of the pamphlet:
The Bank creates money and uses it to buy assets such as government bonds and high quality debt from private companies
Upon recently re-reading Adam Fergusson’s detailed daily chronicle of the collapse of the German fiat currency in 1923, I was struck by what economists call the J-curve effect. It was a matter of years, not weeks, before the full and dire consequences of the policy of printing money became apparent. All of the characters whose lives Fergusson recounts, with the exception of the politicians, could foresee the dreadful consequences of money printing.
But the crisis evolved in phases. As it started to bite, clever Germans worked out that debt would be inflated away and that hard assets would quickly rise in value. At page 109 we learn how in 1922 the clever Hans-Georg von der Osten, borrowed in February to buy a substantial estate, then paid off the entire loan in the autumn with a modest crop grown that year on the land. During that summer he also bought 100 tons of maize from a dealer for 8 million marks, only to sell the same crop back to the dealer a week later for twice the price. With the profits “I furnished the mansion house of my new estate with antique furniture, bought three guns, six suits and three of the most expensive pairs of shoes in Berlin, then spent eight days there on the town”, he boasted.
There are of course many differences between the UK’s economic circumstances now, and those of Germany in the early 1920s. But there are also many parallels. One significant parallel is that Germany’s rulers knew that the country was unable to pay its war debts, and possibly embarked on their programme of currency debasement, to the ire of the Reparations Commission and creditor nations, as a deliberate policy to inflate the problem away.
So in March 2009, in order to address the banking crisis, the UK believed that a £200 bn programme of quantitative easing was an essential monetary policy tool to stimulate the economy and “control inflation”:
The instrument of monetary policy shifted towards the quantity of money provided rather than its price (Bank Rate). But the objective of policy is unchanged – to meet the inflation target of 2 per cent on the CPI measure of consumer prices. Influencing the quantity of money directly is essentially a different means of reaching the same end.
I can only assume that the German government believed that, when the nirvana of modest national debt had been reached, they could end the debasement and somehow revive the economy. However, by 1924 many Germans could not afford food because confidence in the currency was so low that nobody wanted marks. Fiat currencies depend entirely on confidence, and when the confidence bubble is punctured, no matter how slowly the air escapes, it proves exceptionally difficult to repair. Both the US and the UK are now experiencing this. When the UK launched QE in March 2009, gold stood at about £600 per ounce, today the same ounce costs over £900.
I would be grateful for any Bank of England officials to enlighten me as to where my above squaring of QE with Weimar money printing may be mistaken. If our central bankers are unable, perhaps they would be so kind as to acknowledge that their website quotation above is grievously mistaken. QE, far from being a technique of inflation control, represents the introduction of the germ of hyperinflation which, unless stopped or preferably reversed very soon, will continue to grow like a virus within our economy and in turn may wreck our society.
At what level of the pound to gold would the BoE start to lose confidence in the merits of QE? Or is the price of gold in pounds irrelevant? Was Isaac Newton therefore confused in his insistence on a clear relationship between the pound sterling and a specified weight of gold? If that is their view, perhaps the BoE ought to take that famous bar of gold out of their own museum. That would be more consistent with the BoE’s apparent present beliefs: we should forget that the pound was once a hard asset backed by gold, and learn to appreciate that the paper pound exists as a pure confidence asset.
Fergusson’s final paragraph should appear next to those absurd sentences on the Bank of England’s website.
In hyperinflation a kilo of potatoes was worth, to some, more than the family silver; a side of pork more than the grand piano. A prostitute in the family is better than an infant corpse; theft was preferable to starvation…..
Thanks to Ewen Stewart and Andy Duncan who have contributed to this piece.
By David Howden, on 26 April 11
 The UK is in sorry shape today. The British can at least take comfort in knowing that things are still not anywhere near as bad as they were over a half century ago during the gloomy days of the Blitz. Yet in contemplating where Britain is today, and comparing it to other dark periods, it would be well-advised to keep everything in historical perspective.
The Blitz was terrible, but it was far from the worst that could have happened. While the constant fear of bombing, mandatory curfews and destroyed cities rendered a great tragedy on Britain, the steady supply of Nazi bombs saved her from another fate. While German bombers were busy emptying their destructive cargo onto Britain, they were unable to drop a different type of cargo that would have meant not just sudden impairment of the livelihoods of the British (as did the bombs) but their future prosperity as well.
Operation Bernhard was hatched in 1942 by SS Major Bernhard Krüger (whose claim to fame now rests on naming what would become one of the War’s most devious plots after himself). The plan involved flooding the British economy with £5, £10, £20, and £50 notes. In what was the largest counterfeiting operation in history, a team of 142 “counterfeiters” (i.e., inmates) at the Sachsenhausen concentration camp toiled for three years to amass a sizeable British fortune: 8,965,080 Bank of England notes were produced with a total value of £134,610,810.
The initial plan called for bombing runs to drop the currency from the sky. Britons know a good deal when they see one – pounds sent from heaven would be a ray of sunshine in an otherwise dreary wartime economy. As the counterfeit pounds were spent, inflation would be triggered. The once proud British economy would be brought to its knees as skyrocketing prices would foil entrepreneurs’ plans, destroy savings, and otherwise wreak havoc on the economy.
Luckily, the tenacity of the British paid off. The Luftwaffe, increasingly hindered as the war wore on, lacked the bombers to drop the counterfeit notes over the British countryside. Disaster was averted.
And yet today we have a similar plan in action. Mervyn King, governor of the Bank of England, has undertaken his own little “Operation Bernhard.” The base money supply of the United Kingdom – the notes and coins in circulation – has increased by over 75 percent over the last decade. That supply of dingy notes and tarnished coins that weigh down Britons’ pockets has grown by leaps and bounds that Major Krüger could only dream of.
While the Nazi’s could only produce £134,610,810 over the course of the war, this is about 7 percent of what the Bank of England was able to produce in 2010 alone! Even at the height of the operation it is claimed that about 1 million counterfeit notes were produced per month. Even if we concede that all of these notes were of the largest denomination printed (£50), this would still only amount to £600 million a year. Even this massive figure pales in comparison to the approximately 1.9 billion extra pounds of currency that the Bank of England put into circulation last year.
To put it in other words: In the last year the Bank of England pursued an operation that was over twice as effective as the Nazi’s could only dream of during the height of the war. Mervyn King and his colleagues have pursued an inflationary policy the likes of which Britain’s largest enemies could only wish for during the war.
I know that you are supposed to have love for thine enemies, but this all begs the question: Mr King, whose side are you on anyway?
By James Tyler, on 4 March 11
Another classic article, brought forward. This is a speech by James Tyler to the Adam Smith Institute Next Generation Group on 6 October 2009. This speech is also available on hedgehedge.com.
I have spent the best part of the last two decades pitting my wits against the market. It’s an unforgiving game: I’ve seen ups and downs, and many of my rivals buried under an avalanche of hubris, passion, illogical thought and unchecked emotion.
I have witnessed the sheer folly of the ERM crisis, the Asian crisis, the failure of the Gods at Long Term Capital Management and the insanity of the tech boom.
I have enjoyed the ‘NICE’ decade (Non-Inflationary Constant Expansion), and scared myself silly during the credit crisis.
I am a trader.
I risk my own money and live or die by my decisions, and face the threat of personal bankruptcy every time I switch my screens on. I get no salary – indeed I turn up at the start of the month with a large office overhead – a ‘negative’ salary. I have no fancy company pension scheme, no lucrative monopoly or franchise.
I eat what I kill.
Mistakes cost me my livelihood, so, above all, my decisions have to be rooted in practical and logical decision making.
Some have called my kind parasitic, but I would have said that I bring order, efficiency, predictability, stability and deep liquidity to a crucial process: a process that makes the whole world keep ticking.
I make money work.
I make the market in interest rate derivatives: a market born out of the neo classical revolution in finance fostered in Chicago during the 1970s. I am a child of Friedman, Fisher Black, Myron Scholes and the modern international financial system.
My analysis was steeped in the neo-classical, efficient markets paradigm.
Friedman’s ideal was working. Enlightened central bankers guided the free market with gentle nudges and short term liquidity infusions, free floating currencies gently adjusted themselves to the constant flow of new information and efficient and rational markets took all in their stride.
Credit flowed, people got wealthier, economies developed and all was well.
And then the crisis struck.
Continue reading “My Journey to Austrianism via the City”
By Robert Sadler, on 23 February 11
Recent economic data has convinced the Bank of England not to expand its Quantitative Easing program. According to the Office of National Statistics, annual CPI inflation rose from 3.3% in November to 3.7% in December, 2010 and is now currently 4%. The overall expectation is that CPI inflation will peak at 4.4% by the middle of 2011.
This increase in inflation coupled with poor economic data (with GDP contracting 0.5% last quarter) has come as something of a shock to the Bank of England. The Bank was apparently operating under the assumption that printing money was the way to get the economy going. They are surprised that the result has been a significant increase in inflation and a worsening economy.
Rather helpfully, on the Bank’s website there is an explanation of how Quantitative Easing was supposed to improve the economy. Quite clearly, the Bank explains that they purchased British Government bonds (gilts) and high quality (investment grade) bonds from private sector companies (banks, pension funds, insurance companies and non-financial institutions). The Bank’s concern was that there was too little money “circulating” in the economy. Using this method, the Bank was able to inject the much needed money directly into the economy and the companies that needed it. The idea was two-fold; a) asset prices increase, wealth increases and spending increases; b) more money, means more spending, bank reserves increase, meaning more lending, spending and income increases, inflation arrives at the magic 2% rate and we all live happily ever after, growing fat off of the magic wealth creation machine at the Bank. But there is a dark side to this fairy tale and at the risk of sounding clichéd, it is because in this case, more money really does mean more problems.
The problem is that the Bank is operating under the rather naïve assumption that printing money and rising prices mean that they are creating value. If this were true, none of us would need to work. The government could just issue us all with paper, ink and printing presses. Whenever we needed to buy something we could just print off some money and go to the shops and buy what we need. And of course, prices would rise, the shops would make lots of profits and apparent wealth would increase. There is one nagging doubt however. Who would make all the goods that we would buy, if we are all sitting at home printing money? Perhaps we could get the Morlocks to do it. Or maybe specially trained chimps.
Clearly, the Wizards of Oz, currently residing at the Bank of England, do not understand how value is created, how capital grows and how the wealth in society is generated. To create value one must produce something of value, a good that someone can use to improve their wellbeing or allow them to subsist. This good can be sold for money and the money can be used for consumption, held as a cash balance or to improve the tools needed to produce a greater quantity and quality of goods. Ultimately, all money will be spent on either a consumer good (like a loaf of bread or a new pair of shoes) or a capital good (like a baker’s oven or shoe-making machinery). The latter choice would result in an increase in capital (the value of all capital goods) and capital goods, and in the long run, a general increase in wealth. The increase in wealth occurs because an improvement in the quality and quantity of capital goods allows us to create a greater number of better quality consumer goods in a shorter period of time. This increase in the supply of consumer goods means that their price will fall resulting in a reduction in the cost of living for the society at large. We will all be better off. The important concept to take away is that for this increase in wealth to occur, somebody had to sacrifice some of their consumption to instead purchase a capital good (otherwise known as an income producing asset). This increases the price of income producing assets relative to consumer goods. From the perspective of a consumer like you and me, the goods we buy become cheaper and in a healthy economy, the prices of consumer goods fall over time.
The Bank of England does not believe that any sacrifice is needed today for an increase in wealth tomorrow. In the Land of Oz you do not need to sell something of value in order to get money in exchange, you can just print money instead. Obviously, printing up banknotes does not create anything of value. What happens instead is the reverse of the process described above. The increased supply of money, according to the fundamental laws of economics, will reduce its purchasing power, meaning that the relative prices of consumer goods will rise over time. This will increase the cost of living for people in general, meaning their real wages will fall. Because the cost of labour is now comparatively cheaper, rather than invest in an increase in capital goods, companies will invest in labour instead (Jesus Huerta De Soto, 2009). This means there will be a lower quantity and quality of capital goods and a reduction in the future supply of consumer goods. For the average person, this means a lower salary and a smaller selection of more expensive goods to spend it on. Most of us become poorer.
But not all of us will become poorer. By printing this money and handing it over to a favoured few in society (i.e. the banks) this is in one sense, handing them nothing and in another sense, pure and simple counterfeiting. This is because, in the case of Quantitative Easing, the banks will trade this money for real or financial assets, or to their employees in exchange for their services. This increased monetary demand for financial assets or banking services will bid up their prices. The assets can then be sold in the near term at a profit and the banking employees will spend their increased salaries and bonuses on consumer goods before prices start to rise. Bankers will certainly feel wealthier. In fact, this whole process represents a wealth transfer from one group of people in society to the banks and a shadow tax on much of the population. This is because the early recipients of the new money (the bankers and the Government) will get to spend this money before the prices rise significantly. Slowly this new money will be dispersed around the economy but the further you are from the source the less it will be worth when you finally receive it.
The main beneficiaries of Quantitative Easing therefore, are the Government and the banks. The banks buy gilts from the Government and then sell them to the Bank of England (just under £200bn’s worth) at a profit. The Bank of England pays for these gilts with freshly printed money. Thus the Government has a ready buyer for its debt and the banks become more profitable and apparently more stable. Because of their now greater reserves and new found stability, the official rationale behind Quantitative Easing was that banks would then lend out these reserves to businesses and households thus stimulating the economy. Except, in fact the opposite has occurred. The economy has contracted, inflation is continuing to rise, net lending is down and unemployment has risen.
With a firm understanding of the basics of how wealth is created the Bank of England would have known this would happen. Unfortunately, they operate under the Keynesian delusion of how the world works and their main objective would appear to be saving the banks (because we are all doomed without them) rather saving the economy. With inflation getting higher and higher one might wonder why Mervyn King, the Governor of the Bank of England, does not simply raise interest rates or resell the gilts. However, this would set the Bank of England’s plan into reverse, with higher rates leading to lower asset values, weakened balance sheets and an increase in mortgage defaults, leading to more bank losses and bankruptcies.
Clearly, the Bank of England’s plan is doomed to failure and has been from the start. Mervyn King would have greater luck trying to empty the ocean with a bucket. The problem is two-fold; a) the Bank of England views the recovery or liquidation stage of the business cycle as a problem to be solved and; b) it tries to solve this problem by doing more of what caused this problem in the first place. This “solution” has prevented the necessary liquidation of unprofitable projects and write-offs of bad loans, and has continued to subsidise inefficient operations. Quantitative Easing has resulted in a transfer of wealth from society at large to the banks and the Government, and has vastly extended the length of what would have been a short but sharp recession. Quantitative Easing has made us poorer while benefiting a select few in society.
This is a crime by any measure.
By David Howden, on 14 January 11
The One Hundred Twelfth United States Congress opened the year with a reading of the American Constitution. Though this was probably more of a show than anything, it does serve a useful function. For better or worse, this government has been elected to serve the electorate to the best of its ability and within the confines of what the law permits. The American Congress was originally granted territorial monopoly rights to make and change the law of the American land. It was not, however, given free rein in this regard. The power of the Constitution is that it delineates the extent of the power endowed to Congress by the people, and where those powers end.
While it is refreshing to see the political establishment paying at least lip service to its original grants and privileges, there exists one other set of territorial monopolists that must be reminded every now and again of their purpose.
The world’s central banks – the Federal Reserve in the States, or the Bank of England for the United Kingdom as examples – were granted a territorial monopoly right over the issuance and control of the money supply in their respective jurisdictions. This grant was not made without limits. These limits are what are widely recognized as keeping these monopolists free from outside interference, but also preventing them from unduly interfering with the events outside their domain.
Perhaps the governors of the Bank of England should start each New Year by gathering around Mervyn King while he reads the original purpose of the Bank. While its scope and mandate is now a little different than the original 1694 Bank of England Act, the Bank’s own website very neatly outlines what its principal objective is, namely “to safeguard the value of the currency in terms of what it will purchase”:
Rising prices – inflation – reduces the value of money. Monetary policy is directed to achieving this objective and providing a framework for non-inflationary economic growth. As in most other developed countries, monetary policy usually operates in the UK through influencing the price at which money is lent – the interest rate.
Two points become clear. First, safeguarding the currency’s value is the primary focus. Second, this will be done so as to promote non-inflationary growth.
The problem is that the Bank of England seems not to realize what the word “inflation” means. It is not only their confusion. The word “inflation” may be one of the most misunderstood and misused words in the English language. Murray Rothbard, on page 990 of his 1962 opus Man, Economy and State, defines in no uncertain terms exactly what inflation is:
The process of issuing pseudo warehouse receipts or, more exactly, the process of issuing money beyond any increase in the stock of specie, may be called inflation. A contraction in the money supply outstanding over any period (aside from a possible net decrease in specie) may be called deflation. Clearly, inflation is the primary event and the primary purpose of monetary intervention.
Any increase in the quantity of money outstanding constitutes inflation. While the Bank of England concentrates on the general price level, it ignores this very important point. After all, the price level can and does change constantly as resource availability alters the relative scarcities of goods, and our own preferences change the values (and hence purchase prices) that we assign to those same scarce goods. Only a definition of inflation grounded in the actual quantity of money gets to the root of the problem: changes in money’s quantity alter its purchasing power.
Second, the Bank seems to want to foster an environment of non-inflationary economic growth. Ignoring for the moment whether the bank is actually pursuing a “low-inflationary” policy, can we say that it is fostering a growth policy?
Given the current state of affairs, which seems to get worse by the day, the unequivocal answer is: no. The United Kingdom’s most pressing problem at this moment is crushing debt levels. The government alone has a little less than 70 percent of the country’s GDP tied up as debt. Interest payments on this debt alone eat away about 3 percent of British GDP each year. The payments on this debt load are stifling, and will only grow over time. One may ask what happened to create such an indebted nation.
The Bank of England’s inflationary policies, since it was nationalized in 1946, have been staggering. As the pound lost value through these policies, an environment where debtors were rewarded for borrowing at the expense of the more prudent creditors was bred. The home of the Industrial Revolution, a once-great source of exports to the world, now finds itself needing to borrow from the world just to meet the interest payments on its debt. This does not sound like a situation that promotes “economic growth”, as the Bank of England eloquently puts it.
Yes, Mervyn King and the rest of the Bank of England would do well to revisit their purpose and mandates at the start of each year. But they would also be well-advised to learn some basic economic theory while they’re at it.
|
|
