Janet Yellen, Politicizing the Fed?

Janet Yellen gave a widely noted speech, Perspectives on Inequality and Opportunity from the Survey of Consumer Finances, at the Conference on Economic Opportunity and Inequality held  by the Federal Reserve Bank of Boston on October 17th.

The speech presented as a if ghostwritten for her by Quincy Magoo, that beloved cartoon character described by Wikipedia as “a wealthy, short-statured retiree who gets into a series of comical situations as a result of his nearsightedness compounded by his stubborn refusal to admit the problem.” What was most interesting was how political was the speech… and what Madame Yellen didn’t say.

Her omission even raised an eyebrow of one of the commentariat’s most astute Fed sympathizers, The Washington Post‘s Ylan Q. Mui. Mui:  “Yellen did not address in her prepared text whether the Fed has contributed to inequality. Nor did she weigh in on whether it may actually be slowing down economic growth, an idea that is gaining traction among economists but which remains controversial.”

Yellen’s speech drew a public comment from the Hon. Steve Lonegan, director of monetary policy for American Principles Project and project director of its sister organization’s grass roots campaign (which I professionally advise):

There is a strong correlation between the post-war equitable prosperity to which Madam Yellen alluded and the post-war Bretton Woods gold-exchange standard.  And there is a strong correlation between the increase in inequality under the Federal Reserve Note standard put into effect by President Richard Nixon to supplant Bretton Woods.

The monetary policy of the United States has a profound impact on wage growth and prices, both domestically and internationally.  Hence the importance of a thorough, objective, and empirical look at its policies — from Bretton Woods through the era of stagflation, the Great Moderation, and the “Little Dark Age” of the past decade.

That is why the Brady-Cornyn Centennial Monetary Commission, and the Federal Reserve Transparency Act which recently passed the House with a massive bipartisan majority, are critical steps forward to ending wage stagnation and helping workers and median income families begin to rise again.  As President Kennedy once said, “Rising tide lifts all boats.”

Madam Yellen addresses four factors in what she calls “income and wealth inequality.”  Madame Yellen stipulates that “Some degree of inequality in income and wealth, of course, would occur even with completely equal opportunity because variations in effort, skill, and luck will produce variations in outcomes. Indeed, some variation in outcomes arguably contributes to economic growth because it creates incentives to work hard, get an education, save, invest, and undertake risk.”

Even with that ostentatious stipulation, the Fed Chair’s speech is amplifying one of the Democratic Party’s foremost election themes, “income inequality.”  The New York Times‘s Neil Irwin observed of this speech: “Nothing about those statements would seem unusual coming from a left-leaning politician or any number of professional commentators. What makes them unusual is hearing them from the nation’s economist-in-chief, who generally tries to steer as far away from contentious political debates as possible.”

Her speech could be read as an Amen Corner to Elizabeth Warren’s stump speech, on behalf of Sen. Al Franken’s reelection effort, that The game is riggedand the Republicans rigged it.Her speech could be read as a little election-season kiss blown to Sen. Franken (D-Mn), who voted for her confirmation and then glowed on Madame Yellen very publicly.

One cringes at the thought that the Fed even might be giving the appearance of playing politics.  To align the Fed, even subtly, with either party’s election themes during an election season would seem a deeply impolitic, and unwise, violation of the Fed’s existential principle of political independence.  House Financial Services Committee chair Jeb Hensarling and Sen. Mike Crapo (R-Id), should he accede to the chairmanship of the Senate Banking Committee, might just wish to call up Madam Yellen for a public conversation about avoiding even the appearance of impropriety.

The Fed’s independence is as critical as it is delicate. To preserve it demands as much delicacy by the officials of the Federal Reserve System as by the Congress. As Barack Obama might say, here is a “teachable moment” for our new Fed chair.

Also troubling is the decision by the Chair to focus her mental energy, and remarks, on four areas entirely outside the Fed’s jurisdiction: resources available for children; higher education that families can afford; opportunities to build wealth through business ownership; and inheritances.  These might be splendid areas for a president’s Council of Economic Advisors (which Madame Yellen chaired, commendably, under President Clinton).  Good topics for a professor emerita at the University of California, Berkeley, Haas School of Business, as is Madam Yellen.

They are, however, at best mere homilies from the leader of the world’s most powerful central bank. We would like to hear Madam Yellen talk about monetary policy and its possible role in the diminishing of economic mobility. It does not seem like too much to ask.

Since Madame Yellen, rightly, is considered an eminent Keynesian (or Neo-Keynesian), why not begin with Keynes? In The Economic Consequences of the Peace, Chapter VI, Keynes addressed this very point. The brilliant young Keynes was addressing the insidious power of inflation, not now in evidence and not portended by the data.  Yet let it be noted that there is more than one way to debauch a currency:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. … By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. …

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

America and the world needs, and rightly expects, the chair of the Federal Reserve to be that one in a million able to diagnose.  Madame Yellen is called upon to step up her game and pivot from pious homilies to the heart of the matter.  If Keynes could call out how bad monetary policy can strike “at confidence in the equity of the existing distribution of wealth,” perhaps so too ought his followers.

What is to be done? Wikipedia also observes of Mr. Magoo that “through uncanny streaks of luck, the situation always seems to work itself out for him, leaving him no worse than before.”  We devoutly hope that Madame Yellen — and, thus, the economy — will be the beneficiary of “uncanny streaks of luck.”  Hope is not a strategy.  Relying on luck tautologically is a dicey way of bringing America, and the world, to a renewed state of equitable prosperity.

Rely on luck?  It really is time to shift gears.  An obvious place for Madame Yellen to begin would be to register active support for the Brady-Cornyn Centennial Monetary Commission designed to conduct a thorough, empirical, bipartisan study of what Fed policies have worked.   What policies of the Federal Reserve have proven, in practice, or credibly portend to be, conducive to equitable prosperity and healthy economic mobility?

Should the correlation between the (infelicitously stated if technically accurate) “40 years of narrowing inequality following the Great Depression” and the Bretton Woods gold-exchange standard be ignored?  Why ignore this?  Should the tight correlation of “the most sustained rise in inequality since the 19th century” with the extended experiment in fiduciary dollar management be ignored? Why ignore that?

What might be learned from the successes of the Great Moderation inaugurated by Paul Volcker?  Is Volcker’s recent call for a “rules-based” system, a position from which Madam Yellen staunchly dissents, pertinent? Discuss.

Madame Yellen?  Let’s have a national conversation about monetary policy and its effects on economic mobility.  It really is time to bring to a decisive end many decades of Magooonomics and the disorders that derive therefrom.  Fire Magoo.  Show the world that you are Keynes’s one in a million.

Originating at


Markets and reality disconnected

The behaviour of financial markets these days is frankly divorced from reality, with value-investing banished.

Markets have become distorted by Rumsfeld-knowns such as interest rate policy and “market guidance”, and Rumsfeld-unknowns such as undeclared market intervention by the authorities. On top of these distortions there is remote investing by computers programmed with algorithms and high-frequency traders, unable to make human value-assessments.

Take just one instance of possible “market guidance” that occurred this week. On Thursday 16th October, James Dullard of the St Louis Fed hinted that QE might be extended. In the ensuing four trading sessions the Dow rallied over 5%. Was this comment sparked by signs of slowing economic growth, or by a desire to buoy up sliding equity markets? Then there is the vested interest of keeping government funding costs low, which raises the question whether or not exceptionally low bond yields, particularly in the Eurozone, are by design or accidental.

Those who support the theory that it is all an evil plot will also note that governments and their central banks through exchange stability funds (set up with the explicit purpose of market intervention), wealth funds and state pension funds have some $30 trillion to direct as they see fit. The reality is that there is intervention across a range of markets; but most of the mispricing is in the hands of private, not government investors. For evidence look no further than the record level of brokers’ loans to buyers of equities, who with greed worthy of a latter-day South-Sea Bubble seek to gear up their speculative profits.

These are not markets with widespread public participation, buying dot-coms and the like. Instead ordinary people have given their savings and pension funds to professionals who speculate on their behalf. It is the professionals who talk about the Yellen put, meaning the Fed simply won’t let prices fall significantly. We can fret about who is actually responsible for market distortions, instead we should ask who benefits.

Governments: in the past they have covered their debts through a process dubbed financial repression, when artificially low interest rates and bond yields were the principal mechanism whereby wealth is transferred from savers to the government. This process still goes on today. Forget government inflation figures: when did a bank deposit net of taxes last give a positive return after your cost of living increases?

Zero interest rate policy lays the process bare, and turns savers into borrowers. Mr Average has replaced savings with mortgages and car loans. And while the elderly and other passive savers are still defenceless against financial repression, the process has taken on a new twist. The transfer of wealth to governments now targets investment managers.

Investment and hedge funds we invest with together with the banks which take our deposits speculate on our behalf. They think that with a Yellen or Draghi put underwriting markets a ten-year government bond with a two per cent yield is an attractive investment. In doing so they are transferring financial resources to governments in a variation on old-fashioned financial repression.

Our dysfunctional markets have become little more than the essential prerequisite, as Louis XIV’s finance minister Colbert might have said, to plucking the goose for the largest amount of feathers with the minimum of hissing.


Four Reasons the Bernanke-Yellen Asset-Price Inflation May Be Nearing Its End

There are strong indications that the remarkable run up of asset prices in the last few years is beginning to run out of steam and may be on the verge of collapse. We will leave aside the question of whether the asset inflation is symptomatic of a garden-variety inflationary boom or is a more virulent bubble phenomenon in which prices are rising today simply because buyers anticipate that they will rise tomorrow.

The Evidence

1. The dizzying climb of London real estate prices since the financial crisis, noted in a recent postby Dave Howden, may be fizzling out. Survey data from real-estate agents indicate London housing prices in September fell 0.1 percent from August, their first decline since November 2012. Meanwhile, an index of U.K. housing prices declined for the first time in 17 months. In explaining the “pronounced slowdown” in the London real estate market, the research director of Hometrack Ltd. commented, “Buyer uncertainty is growing in the face of a possible interest-rate rise, a general election on the horizon and recent warnings of a house-price bubble,” which is playing out “against a backdrop of tougher mortgage affordability checks and limits on high loan-to-income lending.”

2. Just released data from the Dow Jones S&P/Case Schiller Composite Home Price Indices through July 2014 shows a marked deceleration of U.S. housing prices. 17 of the 20 cities included in the 20-City Composite Index experienced lower price increases in July than in the previous month. Both the 10- and 20-City Index recorded a 6.7 percent year-over-year rate of increase, down sharply from the post-crisis peak of almost 14 percent less than a year ago.

3. More ominously, U.S. Total Household Net Worth (HNW), as recently reported by the Fed for the second quarter of 2014, reached a record high of $81.5 trillion, over $10 trillion higher than the level at the peak of the asset bubble in 2007. Furthermore, the 2014 figure was $20 trillion higher than the level of the post-crisis — and pre-QE — year of 2008, when asset prices and the real structure of production were just beginning to adjust to the massive capital consumption and malinvestment wreaked by the Great Asset Inflation of 1995-2005. The increase in household wealth has been driven mainly by the increase in prices of financial assets which was generated by the Fed’s zero interest rate policy and its force feeding of additional bank reserves into the financial system via its quantitative easing programs. (See chart below). These policies falsify profit and wealth calculations and give rise to unsustainable investments and overconsumption. Once interest rates begin to adjust to their natural levels, however, asset prices are revealed to be grossly inflated and collapse. The asset inflation may be reversed even without an increase of interest rates, if people lose confidence in the narratives fabricated and propagated by government policymakers, economists, and the financial commentators to promote the continuation of the inflation in asset markets. Furthermore it is risible to believe that real wealth in the US in terms of the factories and other capital goods to which financial assets are merely ownership claims, has increased by over one-third since 2008, especially in light of the additional malinvestment and overconsumption caused by monetary and fiscal policy “stimulus” since then.

4. If we look at HNW in historical perspective, we note that, in the chart below, the HNW/GDP (or wealth to income) ratio is now at an all-time high. From 1952 to the mid-1990s this ratio averaged a little more than 350 percent and never went above 400 percent until 1998 as the dot-com bubble was blowing up. It peaked at nearly 450 percent before the bubble collapsed causing the ratio to plummet to slightly below 400 percent, indicating the beginning of the purging of the illusory capital gains created during the asset inflation.

But just as the adjustment was beginning to take hold in 2002, the Greenspan Fed played the deflationphobia card, driving interest rates to postwar lows and pumping up the money supply (MZM) by $2 trillion from beginning of 2001 to the end of2005. During this second phase of the Great Asset Inflation, the HNW/GDP ratio again reached a new high before plunging below 400 percent during the financial crisis. And, tragically, the nascent readjustment of financial markets to the underlying reality of the economy’s shattered and shrunken production structure was yet again aborted by government intervention in the form of the heterodox monetary policies of Bernankeism combined with the outsized deficits of the Obama administration. These policies succeeded in driving the HNW/GDP ratio to yet another new high, but without having the expected stimulatory effect on consumption and investment spending.


In sum, I do not expect that the ratio will rise much above 500 percent — Americans have just not saved enough since 1995 to have increased their real wealth from 3.5 times to 5 times their annual income. Nor is there much reason to expect a plateau anywhere near the current level. Once interest rates begin to rise — and rise they must, whether as a result of Fed policy or not — the end of the asset price inflation will be at hand. The result will be another financial crisis and accompanying recession. The Fed and the Administration will no doubt attempt to bail and stimulate their way out but given the still dangerously enervated state of the financial system and the real economy, it will be like dosing a horse that has already been overdosed to death. Thus my forecast for the U.S. economy one year to two years out echoes that of Clubber Lang, the villain in the movie Rocky III. When questioned about his forecast for the forthcoming fight against Rocky, Lang replied, “Pain.”


Fed introduces new economic indicator to better assess the labour market

Economists at the Federal Reserve have devised a new indicator, which they hold will enable US central bank policy makers to get better information regarding the state of the labour market. The metric is labelled as the Labour Market Conditions Index (LMCI).

Note that one of the key data Fed policy makers are paying attention to is the labour market. The state of this market dictates the type of monetary policy that is going to be implemented.

Fed policy makers are of the view that it is the task of the central bank to navigate the economy toward a path of stable self-sustaining economic growth.

One of the indicators that is believed could inform policy makers about how far the economy is from this path is the state of the labour market.

A strengthening of the labour market is seen as indicative that the economy may not be far from the desired growth path.

A weakening in the labour market is interpreted as indicating that the distance is widening and the economy’s ability to stand on its own feet is diminishing.

Once the labour market shows strengthening this also raises the likelihood that the Fed will reduce its support to the economy. After all, to provide support whilst the economy is on a path of stable self-sustained growth could push the economy away from this path towards a path of accelerating price inflation, so it is held.

Conversely, a weakening labour market conditions raises the likelihood that the Fed will either maintain or strengthen its loose monetary stance. Failing to do so, it is held, could push the economy onto a path of price deflation and economic crisis.

The uniqueness of the LMCI, it is held, is that it covers a broader range of labour market pieces of information thereby raising the likelihood of depicting a more correct state of labour market conditions than an individual piece of information could provide.

The LMCI is derived from 19 indicators such as the number of people employed full time and part time, the labour participation rate, the hiring rate, hiring plans etc.

When the index is rising above the zero line it is interpreted that labour market conditions are strengthening. A fall in the index below the zero line is taken as a deterioration in the labour market.

In September the index rose by 2.5 points after gaining 2 points in August. Note however that in April this year the index increased by 7.1 points. Following the logic of Fed policy makers and assuming that they will pay some attention to the LMCI, if the index were to continue strengthening then the Fed may start considering tightening its monetary stance.


We suggest that the Fed’s responses to the LMCI are not going to bring the economy onto a path of stability and self-sustaining economic growth, but on the contrary will lead to more instability and economic impoverishment.

The state of a particular indicator such as the LMCI cannot tell us the state of the pool of real wealth i.e. whether it is expanding or shrinking.

It is not important to have people employed as such but to have them employed in wealth generating activities. Employment such as digging ditches and building non-wealth generating projects are only depriving wealth generators from the expansion of the pool of real wealth. This undermines the ability to grow the economy and leads to economic misery.

The belief that the Fed can navigate and grow the economy is wishful thinking. All that Fed officials can do is to pump money and tamper with the interest rate structure. None of this however can lead to economic growth.

The key to economic growth is the expansion in capital goods per individual. This expansion however must be done in accordance with the dictates of the free market and not on account of an artificial lowering of interest rates and monetary pumping.

Loose monetary policy will only result in the expansion of capital goods for non-wealth generating projects i.e. capital consumption.


Only by means of the allocation of resources in accordance with the dictates of the market can a wealth generating infrastructure be established. Such infrastructure is going to lead to economic prosperity.

To conclude then, the Fed’s new indicator adds more means for US central bank officials to tamper with the economy, which will lead to greater economic instability and economic impoverishment.


Summary and conclusions

The Fed has introduced a new economic indicator labelled the Labour Market Conditions Index (LMCI). The LMCI is derived from 19 labour market related indicators; hence it is held it is likely to provide a more realistic state of the labour market.

This in turn will enable Fed policy makers to navigate more accurately the economy toward a path of stable non-inflationary economic growth.

We suggest that what is required is not information about the strength of the labour market as such but information on how changes in labour market conditions are related to the wealth generation process.

This however, the LMCI doesn’t provide. Since Fed officials are likely to react to movements in the LMCI we hold this will only lead to a deepening in the misallocation of resources and to a further weakening of the wealth generation process.


Interview with St. Louis Fed Vice President on Bitcoin

Dr David Andolfatto, who is Vice President of the St. Louis Fed, has been one of the most forward-looking people at central banks around the world when it comes to crypto-currencies. Here he speaks with Max Rangeley, Editor at The Cobden Centre, and gives his views on what Bitcoin means for commerce, finance, and the dollar itself.

Max: How have you found the reactions to Bitcoin within the Fed?

David: Bitcoin is barely on the radar screen for most Fed researchers and policymakers. This is to be expected, given the large size of the Fed’s balance sheet and the debate over how to conduct monetary policy with the existence of large excess reserves. But I am aware of a small group of researchers scattered throughout the Fed system that seem interested in the Bitcoin phenomenon. Some, like Francois Velde of the Chicago Fed, have written nice primers on the phenomenon. I am also aware of a cryptocurrency workshop that meets monthly at the New York Fed. The reaction of most people (who study it) might be described as “academic agnosticism” in the sense that people are curious, but not enthusiastically in favor or against the idea.

Max: How do you see Bitcoin being used in the future? Do you foresee private currencies being commonly used on the high street alongside state-backed currencies, or remaining largely online phenomena?

David: Who can say how the future will evolve, especially in this space? My best guess is that Bitcoin will find a niche market. It’s cool to use bitcoin to pay for your Starbucks latte on university campuses (this is what my university is doing). It may very well find a place on the high street, at least among some shops catering to the “cool” crowd. But for advanced economies, at least, it is hard to see how consumers will benefit directly by using bitcoins instead of dollars or pounds. As Satoshi Nakamoto wrote in his seminal 2008 paper introducing Bitcoin, “…the [current] system works well enough for most transactions…”

Max: If the use of private currencies became more widespread, do you think that central banks would ever track monetary aggregates in circulation, even if just approximately, much as M2, M3 etc are tracked now?

David: Anything is possible, but I doubt it. One issue is that there many of these “wildcat” currencies, with more appearing every day (every online game has its own currency for example, as do most social media sites). In a sense, these currencies are “local” monies (much like the local currencies that have always existed, like the Ithaca hour, for example). I’m not sure how a statistical agency could keep track of all these little local currencies, or whether it would even be worthwhile to do so. But who knows?

Max: If private currencies were to become widely used around the world, do you think that this could have an effect on the business cycle, since central banks would not have as much control over monetary factors?

David: I do not think it would have much of an effect on the business cycle, which I think is rooted more in “real” and “financial” factors, rather than “monetary” factors, per se.

Max: You mentioned in your presentation on Bitcoin that although supply is fixed, demand can fluctuate significantly, which causes volatility, would you say this is a weakness inherent in private currencies, or is there the possibility that algorithms could evolve to incorporate a degree of elasticity?

David: Remember that Bitcoin is *more* than a private currency: it is a payment system and monetary policy with *no trusted intermediary* involved. Most private currencies entail the use of trusted third parties. EVE online, for example, an online game founded in 2003 has evidently managed its money supply in a manner that keeps its value relatively stable. It may be possible to code an “elastic money supply” rule in the Bitcoin protocol, but it is not immediately clear to me how this might work. Injecting new money into the system would be easy. The tricky part would be in how to destroy money (having the algorithm debit Bitcoin wallets that are secured by private keys).

Max: You mentioned that you welcome the competition for central banks; if private currencies became widely used, could it chip away at American supremacy, a degree of which is based on the dollar, the so-called “exorbitant privilege”?

David: In my view, America supremacy is not based on the dollar. The status of the dollar simply reflects American supremacy, which is based fundamentally on the structure of that economy (something “real” not “monetary”). The America dollar already faces stiff competition from a variety of alternative candidates, including the Yen, the Euro, and gold. If gold cannot displace the USD, why would we expect Bitcoin to?


Does low US price inflation provide room for a more aggressive Fed?

The US Federal Reserve can keep stimulating the US economy because inflation is posing little threat, Federal Reserve Bank of Minneapolis President Kocherlakota said. “I am expecting an inflation rate to run below 2% for the next four years, through 2018”, he said. “That means there is more room for monetary policy to be helpful in terms of … boosting demand without running up against generating too much inflation”.

The yearly rate of growth of the consumer price index (CPI) stood at 1.7% in August against 2% in July and the official target of 2%. According to our estimate the yearly rate of growth of the CPI could close at 1.4% by December. By December next year we forecast the yearly rate of growth of 0.6%.

Shostak CPI

It seems that the Minneapolis Fed President holds that by boosting the demand for goods and services by means of an additional monetary pumping it is possible to strengthen the economic growth. He believes that by means of strengthening the demand for goods and services the production of goods and services will follow suit. But why should it be so?

If by means of monetary pumping one could strengthen the economic growth then it would imply that by means of monetary pumping it is possible to create real wealth and generate an everlasting economic prosperity.

This would also mean that world wide poverty should have been erased a long time ago, after all most countries today have central banks that possess the skills of how to pump money. Yet world poverty remains intact.

Despite the massive monetary pumping since 2008 and the policy interest rate of around zero Fed policy makers seem to be unhappy with the so-called economic recovery. Note that the Fed’s balance sheet, which stood at $0.86 trillion in January 2007 jumped to $4.4 trillion by September this year – a monetary pumping of almost $4 trillion.

Shostak Fed Balance Sheet

We suggest that there is no such thing as an independent category called demand. Before an individual can exercise demand for goods and services he/she must produce some other useful goods and services. Once these goods and services are produced individuals can exercise their demand for the goods they desire. This is achieved by exchanging things that were produced for money, which in turn can be exchanged for goods that are desired. Note that money serves here as the medium of the exchange – it produces absolutely nothing. It permits the exchange of something for something. Any policy that results in monetary pumping leads to an exchange of nothing for something. This amounts to a weakening of the pool of real wealth – and hence to reduced prospects for the expansion of this pool.

What is required to boost the economic growth – the production of real wealth – is to remove all the factors that undermine the wealth generation process. One of the major negative factors that undermine the real wealth generation is loose monetary policy of the central bank, which boosts demand without the prior production of wealth. (Once the loopholes for the money creation out of “thin air” are closed off the diversion of wealth from wealth generators towards non-productive bubble activities is arrested. This leaves more real funding in the hands of wealth generators – permitting them to strengthen the process of wealth generation i.e. permitting them to grow the economy).

Now, the artificial boosting of the demand by means of monetary pumping leads to the depletion of the pool of real wealth. It amounts to adding more individuals that take from the pool of real wealth without adding anything in return –an economic impoverishment.

The longer the reckless loose policy of the Fed stays in force the harder it gets for wealth generators to generate real wealth and prevent the pool of real wealth from shrinking.

Finally, the fact that the yearly rate of growth of the CPI is declining doesn’t mean that the Fed’s monetary pumping is going to be harmless. Regardless of price inflation monetary pumping results in an exchange of nothing for something i.e. an economic impoverishment.


Valuing gold and turkey-farming

Today’s financial markets are built on the sand of unsound currencies. Consequently brokers, banks and investors are wedded to monetary inflation and have lost both the desire and ability to understand gold and properly value it.

Furthermore governments and central banks in welfare-driven states see markets themselves as the biggest threat to their successful management of the economy, a threat that needs to be tamed. This is the backdrop to the outlook for the price of gold today and of the forces an investor in gold is pitted against.

At the heart of market control is the substitution of unsound currency for sound money, which historically has been gold. Increasing the quantity of currency and encouraging banks to increase credit out of thin air is the principal means by which central banks operate. No matter that adulterating the currency impoverishes the majority of the population: central banks are working from the Keynesian and monetarist manual of how to manage markets.

In this environment an investor risks all he possesses if he insists on fighting the system; and nowhere is this truer than with gold. Gold is not about conventional investing in this world of fiat currencies, it is about insurance against the financial system collapsing under the weight of its own delusions. Regarded as an insurance premium against this risk, gold is common sense; and there are times when it is worth increasing your insurance. In taking that decision, an individual must be able to evaluate three things: the relative quantities of currency to gold, the likelihood of a systemic crisis and the true cost of insuring against it. We shall consider each of these in turn.

The relationship of currency to gold

Not only has the quantity of global currency and bank credit expanded dramatically since the Lehman crisis, it is clear that this is a trend that cannot now be reversed without triggering financial chaos. In other words we are already committed to monetary hyperinflation. Just look at the chart of the quantity of US dollar fiat money and note its dramatic growth since the Lehman crisis in 2008.

FMQ 26092014

Meanwhile, the quantity of above-ground stocks of gold is growing at less than 2% annually. Gold is therefore getting cheaper relative to the dollar by the day. [Note: FMQ is the sum of all fiat money created both on the Fed’s balance sheet and in the commercial banks. [See here for a full description]

Increasing likelihood of a systemic crisis

Ask yourself a question: how much would interest rates have to rise before a systemic crisis is triggered? The clue to the answer is illustrated in the chart below which shows how lower interest rate peaks have triggered successive recessions (blue shaded areas are official recessions).

Effective Fed Funds 26092014

The reason is simple: it is the accumulating burden of debt. The sum of US federal and private sector debt stands at about$30 trillion, so a one per cent rise in interest rates and bond yields will simplistically cost $300bn annually. The increase in interest rates during the 2004-07 credit boom added annual interest rate costs of a little over double that, precipitating the Lehman crisis the following year. And while the US this time might possibly weather a two to three per cent rise in improving economic conditions, much less would be required to tip other G8 economies into financial and economic chaos.

The real cost of insurance

By this we mean the real price of gold, adjusted by the rapid expansion of fiat currency. One approach is to adjust the nominal price by the ratio of US dollars in circulation to US gold reserves. This raises two problems: which measure of money supply should be used, and given the Fed has never been audited, are the official gold reserves as reported to be trusted?

The best option is to adjust the gold price by the growth in the quantity of fiat money (FMQ) relative to the growth in above-ground stocks of gold. FMQ is constructed so as to capture the reversal of gold’s demonetisation. This is shown in the chart below of both the adjusted and nominal dollar price of gold.

Gold USD 26092014

Taken from the month before the Lehman collapse, the real price of gold adjusted in this way is $550 today, based on a nominal price of $1220. So in real terms, gold has fallen 40% from its pre-Lehman level of $920, and has roughly halved from its adjusted high in 2011.

So to summarise:

• We already have monetary hyperinflation, defined as an accelerating debasement of the dollar. And so for that matter all other currencies that are referenced to it are on a similar course, a condition which is unlikely to be halted except by a final systemic and currency crisis.
• Attempts to stabilise the purchasing power of currencies by raising interest rates will very quickly develop into financial and economic chaos.
• The insurance cost of owning gold is anomalously low, being considerably less than at the time of the Lehman crisis, which was the first inkling of systemic risk for many people.

So how is the global economy playing out?

If the economy starts to grow again a small rise in interest rates would collapse bond markets and bankrupt over-indebted businesses and over-geared banks. Alternatively a contracting economy will increase the debt burden in real terms, again threatening its implosion. So the last thing central banks will welcome is change in the global economic outlook.

Falling commodity prices and a flight from other currencies into the dollar appear to be signalling the greater risk is that we are sliding into a global slump. Even though large financial speculators appear to be driving commodity and energy prices lower, the fact remains that the global economy is being undermined by diminishing affordability for goods and services. In other words, the debt burden is already too large for the private sector to bear, despite a prolonged period of zero official interest rates.

A slump was halted when prices collapsed after Lehman went bust; that time it was the creation of unlimited money and credit by the Fed that saved the day. Preventing a slump is the central banker’s raison d’être. It is why Ben Bernanke wrote about distributing money by helicopter as the final solution. It is why we have had zero interest rates for six years.

In 2008 gold and oil prices fell heavily until it became clear that monetary stimulus would prevail. Equities also fell with the S&P 500 Index down 60% from its October 2007 high, but this index was already 24% down by the time Lehman failed.

The precedent for unlimited creation of cash and credit has been set and is undisputed. The markets are buoyed up by a sea of post-Lehman liquidity, are not discounting any trouble, and are ignoring the signals from commodity prices. If the economic downturn shows any further signs of accelerating the adjustment is likely to be brutal, involving a complete and sudden reassessment of financial risk.

This time gold has been in a bear market ahead of the event. This time the consensus is that insurance against financial and systemic risk is wholly unnecessary. This time China, Russia and the rest of Asia are buying out physical bullion liquidated by western investors.

We are being regularly advised by analysts working at investment banks to sell gold. But bear in mind that the investment industry is driven by trend-chasing recommendations, because that is what investors demand. Expecting analysts to value gold properly is as unlikely as farmers telling turkeys the truth about Thanksgiving.


End the Fed’s War on Paychecks

The Democratic Party has made “income inequality” a signature issue for the 2014 (and, presumably, 2016) election cycle.  Democrats, en masse, shout “J’accuse!” at Republicans.  There is a very different story to tell.

“Income inequality” is a crude, and twisted, heuristic for stagnant median family income.   “Income inequality” does not really resonate with voters, asnoted by the Washington Post‘s own Catherine Rampell, with a mountain of evidence showing that Americans don’t begrudge the wealthy their wealth, just are frustrated at the lack of widespread economic opportunity.

So let’s get down to cases.  Stagnant median family income is not the GOP’s fault.  It’s the Fed who done it.

The Atlantic Media Company’s Quartz recently claimed that the Fed has been intentionally keeping a lid on wages.  This has potentially major political implications.  Among other things, this view would allow the Republicans to push the discourse back toward the real problem, wage stagnation.  It can serve to refocus the Congress on the real solution, restoring real, rule-based, integrity to monetary policy as a way to get America moving again.

A culpable Fed gives irony to the fact that it is the Democrats that protect the Fed as if it were the Holy of Holies of the Temple.  What if, as asserted inQuartz, the Fed, by policy, and not the GOP, is the source of wage stagnation?  This opens an opportunity for the GOP to parry the political narrative of “income inequality” and feature the real issue on the mind of the voters and forthrightly to address its core cause, poor monetary policy.

This has been slow to happen because Federal Reserve has exalted prestige. The elite media has a propensity to canonize the Chair of the Fed.   Media adulation has obscured the prime source of the stagnation besetting American wage earners for the past 43 years.

Paul Volcker’s life was exalted (with some real justification), for instance by New York Times prize-winning journalist Joseph B. Treaster as The Making of a Financial Legend.  Downhill from there…

English: Official picture of Janet Yellen from...Official picture of Janet Yellen from FRBSF web site.  (Photo credit: Wikipedia)

Chairman Greenspan was featured on the cover of Time Magazine’s February 15, 1999 issue as the most prominent member of “The Committee To Save The World.”  One of the greatest investigative journalists of our era, Bob Woodward, wrote a deeply in-the-tank hagiography of Alan Greenspan, entitled Maestro. In retrospect, the halo the media bestowed was faux.

The Atlantic Monthly, in its February 12, 2012 issue, featured Fed Chairman Ben Bernanke on its cover as The Hero.  (Hedging its bets, The Atlantic ran a duplicate inside cover referencing him as The Villain.)  Author Roger Lowenstein wrote: “Ben Bernanke saved the economy—and has navigated masterfully through the most trying of times.”  The adulation for Chairman Bernanke, in retrospect, seems overdone.  Even President Obama, at the end of Bernanke’s final term, gave him a not-so-subtle push out the door, as reported by CNN: “He’s already stayed a lot longer than he wanted, or he was supposed to….”

It’s Janet Yellen’s turn for media canonization.  This is premature.

Madame Yellen’s institutional loyalty and obvious decency command this columnist’s respect. Her intentions present as — profoundly — good.  That said, the road to a well-known, notorious, destination is said to be paved with good intentions.  Moreover, canonization demands that a miracle be proven.  None yet is in evidence.

The canonization of Madame Yellen began in earnest with an August 24 article in Politico by Michael Hirsch, The Mystery Woman Who Runs Our Economy. The process was taken up to the next level the very next day in an article by Matt Phillips in QuartzJanet Yellen’s Fed is more revolutionary than Ben Bernanke’s ever was

Hirsch tees it up in Politico nicely:

As has been written, Yellen is clearly passionate about the employment problem. It was no accident that the theme of this year’s Jackson Hole meeting was “labor market dynamics,” and the AFL-CIO’s chief economist, Bill Spriggs, was invited while Wall Street economists were not.

Yellen is also very cagey about whether that’s happening or not: She’s playing her own private game of chicken with inflation, indicating that she wants to see more wage growth for workers (another thing that’s hard to track ahead of time) before she raises rates. Beneath the careful analysis and the caveat-freighted sentences, the bottom line seems to be: “We’re making this up as we go along.”

Phillips, in Quartz, observes that it has been Fed policy to suppress wages for two generations.  Phillips:

From her position as the world’s single most powerful economic voice, the chair of the US Federal Reserve, Janet Yellen, is forcing the financial markets to rethink assumptions that have dominated economic thinking for nearly 40 years. Essentially, Yellen is arguing that fast-rising wages, viewed for decades as an inflationary red flag and a reason to hike rates, should instead be welcomed, at least for now.

It might sound surprising to most people who work for a living, but for decades the most powerful people in economics have seen strong real wage growth—that is, growth above and beyond the rate of inflation—as a big problem.

Phillips then gets to the point, providing what passes for economic wisdom among the enablers of the Fed’s growth-sapping (including wage-enervating) interventions.

Since the end of the Great Inflation, the Fed—and most of the world’s important central banks—have gone out of their way to avoid a replay of the wage-price spiral. They’ve done this by tapping on the economic brakes—raising interest rates to make borrowing more expensive and discourage companies from hiring—as wages started to show strong growth.

Phillips provides this exaltation of Janet Yellen:

If she’s right, and American paychecks can improve without setting off an inflationary spiral, it could upend the clubby world of monetary policy, reshape financial markets, and have profound implications for everything ….

Higher real wages, without exacerbating inflation, indeed would be something to cheer.  That, demonstrably, is possible.  The devil is in the details.

There’s persuasive, even compelling, evidence that the international monetary system is better governed by, and working people benefit from, a smart rule rather than the discretion of career civil servants, however elite.  An important Bank of England paper in 2011, Financial Stability Paper No. 13, contrasts the poor performance, since 1971, of the freelancing Fed with the precursor Bretton Woods, and with classical gold standard, rules.  This paper materially advances the proposition of exploring “a move towards an explicit rules-based framework.”

A rule-based system would represent a profound transformation of how the Fed currently does its business. House Financial Services Committee Chairman Jeb Hensarling (R-Tx) said, in a recent hearing, that “The overwhelming weight of evidence is that monetary policy is at its best in maintaining stable prices and maximum employment when it follows a clear, predictable monetary policy rule.”

Madame Yellen stated that “It would be a grave mistake for the Fed to commit to conduct monetary policy according to a mathematical rule.”  Contrast Madame Yellen’s protest with a recent speech by Paul Volcker in which he forthrightly stated: “By now I think we can agree that the absence of an official, rules-based cooperatively managed, monetary system has not been a great success.  In fact, international financial crises seem at least as frequent and more destructive in impeding economic stability and growth. … Not a pretty picture.”

Madame Yellen’s ability to achieve her (postulated) goal of rising real wages in a non-inflationary environment likely depends on who is right here, Yellen or Volcker.  It is a key issue of the day.  The threshold issue currently is framed as between “a clear, predictable monetary policy rule” and the discretion of the Federal Open Market Committee.  The available rules are not limited to mathematical ones but, to achieve real wage growth and equitable prosperity, the evidence fully supports the proposition that a rule is imperative.

Returning America to consistently higher real wage growth is a Holy Grail for this columnist.  Equitable prosperity, very much including the end of wage stagnation, is a driving objective for most advocates of a rule-based system, very much including advocates of “the golden rule.”

Getting real wages growing is a laudable, and virtuous, proposition.  Premature canonization, however, is a flattering injustice to Madame Yellen … and to the Fed itself.  The Federal Reserve is lost in a wilderness — “uncharted territory” — partly, perhaps mainly, of its own (well-intended) concoction.

The road to the declaration of sainthood requires, according to this writer’s Catholic friends, documentation of miracles.  If this writer may be permitted to play the role of advocatus diaboli for a moment … no American Economic Miracle — akin to the Ludwig Erhard’s German “Economic Miracle,” the Wirtschaftswunder, driven by currency reform — yet appears in evidence.

Expertise, which Chair Yellen certainly possesses in abundance, can lead to hubris … and hubris in disaster as it did in 2008.  Good technique is necessary but not sufficient.

As this writer elsewhere has noted,

Journalist Edwin Hartrich tells the following story about Erhard …. In July 1948, after Erhard, on his own initiative, abolished rationing of food and ended all price controls, Clay confronted him:

Clay:  “Herr Erhard, my advisers tell me what you have done is a terrible mistake. What do you say to that?”

Erhard: “Herr General, pay no attention to them! My advisers tell me the same thing.”

Erhard, famously, proved right, his experts, wrong.

Madame Yellen by dint of her decency and intellect may yet prove capable of restoring the Great Moderation … and the real wage growth, with low inflation, that went with that.  Yet, at best, Great Moderation 2.0 would be, as was its predecessor, a temporary, rather than sustainable, solution. “Making it up as you go along” is a proposition fraught with peril.

At worst, if Madam Yellen has, as observers such as‘s John Tamny detect, a proclivity for cheapening the dollar as a path to real wage growth she easily could throw working people out of the frying pan and into the fires of inflation.  Moreover, the Fed’s proclivities toward central planning may be one of the most atavistic relics of a bygone era.  Central planning, by its very nature, even if well meant, always suppresses prosperity.   As the sardonic statement from the Soviet Union went, “So long as the bosses continue to pretend to pay us we will pretend to work.”

Some who should know better ignorantly, and passionately, still are stuck in William Jennings Bryan’s rhetorically stirring but intellectually vacuous 1896 declaration, “You shall not press down upon the brow of labor this crown of thorns, you shall not crucify mankind upon a cross of gold.”  This is a plank that won Bryan his party’s nomination and cost him the presidency… three times. The electorate knows that cheapening the money is the problem, not the solution.

The Fed, not the gold standard, pressed down the crown of thorns upon labor’s brow. The GOP, rather than playing rope-a-dope on “income inequality,” would do well to dig down to find the monetary rule with which to restore a climate of equitable prosperity and real wage growth.  Results, not intentions, are what counts.

There is abundant evidence that the right rule-based system would not be a “grave mistake” but a smart exit ramp back to growth of real wages.  Anything the Fed does that departs from a dollar price rule is anti-equitable-prosperity.  Anything else hurts all, labor and capital. The Congress, under the leadership of Chairmen Garrett (R-NJ) and Hensarling (R-Tx), whose committee has in front of it the Federal Reserve Accountability and Transparency Act and Joint Economic Committee Chairman Kevin Brady’s (R-Tx) Centennial Monetary Commission, at long last, is bestirring itself. Now is the right time to amp up the crucial debate over monetary policy … by enacting both of these pieces of legislation.


The Taylor Rule Won’t Save Us

[Editor's Note: This article, by Mateusz Machaj, first appeared at]


Various criticisms have been raised against the Fed, not only from the side favoring the abolition of central banking, but also from the side of those who argue that the Federal Reserve is indispensable for stability. One of those arguments came from respected economist John Taylor, who is the author of the often mentioned “Taylor Rule” on how to conduct monetary policy, with two House Republicans recently proposing to impose this “rule” on the Fed .

Like Taylor, politicians who advocate for such a rule blame huge credit expansion for the Great Recession. Unfortunately such policymakers are usually not convinced by the Austrian arguments in favor of abolition of the Federal Reserve. Instead they are convinced by John Taylor’s statistical demonstrations. According to Taylor, the Fed set the interest rates too low in the beginning of this century, which led to an unsustainable real estate boom. He adds nonetheless: if only the central bank followed his rule of proper interest rate levels, then monetary policy would work very well.

For Taylor, the Federal Funds rate in recent years should have looked something like this:

The first thing to note about the Taylor Rule is that, strictly speaking, there is no such thing as one universal Taylor Rule. There are many possible Taylor Rules, depending on a variety of factors, on which there is no agreement. Any version of the rule crucially depends on the usage of mathematical variables and their coefficients in the used equation, which is used for calculating the “right” level of interest rates set by the central bank. Those main variables are price inflation and the so called “output gap,” a difference between “actual output” and “potential output.”

Depending on which variables we exactly pick and how we use them, we can have different rules, and therefore different interest rate policy recommendations. It is all well documented in the mainstream literature. Economists disagree how to measure “potential output” (should we use trends, econometric models, or “production function models”?) and there is no agreement how much importance should be assigned to it. There are discussions about the nature of the data that is being used — should it be the one registered currently, or real-time data, or should it be somehow adjusted, since every data set will sooner or later become revised data? Or perhaps since monetary policy takes time we should focus more on the predicted data, rather than just look at the immediate past? We can add to this the Austrian flavor: there are problems with proper price inflation measurements (various indices can differ significantly), and even the actual output measurements can be questioned as proper indicators of economic activity.

It is in fact the case that one can come up with several versions of the Taylor Rule. For example, we could come up with one that would recommend lower interest rates than what we had at the beginning of this century or we could come up with a version of the rule that would recommendhigher interest rates. Or we could come up with one that suggests no change. Research does not give us any clear answer which version of the rule should be chosen.

One particular version which John Taylor is using for his criticism of Alan Greenspan, for example, serves as an ex post demonstration that interest rates should have been higher. Yet there is nothing really that special about this inference. After the fact, anyone can come up with an alternate version of any rule to demonstrate that interest rates should have been higher.

The crucial question to be answered is the following: can reliance on one particular version of the Taylor Rule pave the way for a bubble-proof economy? As described above, a Taylor Rule in any of its versions can at best target the balance between a chosen index for “price inflation” and a chosen way of measuring the invented concept of aggregate “potential output.”

The problem is that targeting either of those macroeconomic variables is not a recipe forintertemporal coordination understood in the Hayekian sense: as coordination between successive stages of production. In his major works Hayek proved that targeting one selected variable, such as price inflation, is not a proper formula for macroeconomic stability. Actually, stabilizing the index may ultimately cause macroeconomic destabilization. It is the same case with Taylor Rules, although in the rule the concept of “potential output” is hidden. Yet this potential output describes production in the aggregate, so it cannot capture the notion of intertemporal coordination among many acting individuals in countless industries.

Malinvestment bubbles are still possible when the central bank follows Taylor Rules, because by targeting potential output and price inflation the central bank triggers artificial credit expansions. For an example, we need only look to the dot-com bubble which happened even though the federal funds rates were actually significantly higher in the nineties than the most-used version of the Taylor Rule would recommend at that time.

The answer to the Taylor Rule is the Hayek Rule, which is the rule of balancing savings with investments in truly free financial markets. Meanwhile, we must endure the current situation of a market stimulated by the central bank with its pretense of knowledge about the “right” price for money and credit.


The wages-fuel-demand fallacy

In recent months talking heads, disappointed with the lack of economic recovery, have turned their attention to wages. If only wages could grow, they say, there would be more demand for goods and services: without wage growth, economies will continue to stagnate. It amounts to a non-specific call to stimulate aggregate demand by continuing with or even accelerating the expansion of money supply. The thinking is the same as that behind Bernanke’s monetary distribution by helicopter. Unfortunately for these wishful-thinkers the disciplines of the markets cannot be bypassed. If you give everyone more money without a balancing increase in the supply of goods, there is no surer way of stimulating price inflation, collapsing a currency’s purchasing power and losing all control of interest rates.

The underlying error is to fail to understand that economising individuals make things in order to be able to buy things. That is the order of events, earn it first and spend it second. No amount of monetary shenanigans can change this basic fact. Instead, expanding the quantity of money will always end up devaluing the wealth and earning-power of ordinary people, the same people that are being encouraged to spend, and destroying genuine economic activity in the process.

This is the reason monetary stimulation never works, except for a short period if and when the public are fooled by the process. Businesses – owned and managed by ordinary people – are not fooled by it any more: they are buying in their equity instead of investing in new production because they know that investing in production doesn’t earn a return. This is the logical response by businesses to the destruction of their customers’ wealth through currency debasement.

Let me sum up currency debasement with an aphorism:

“You print some money to rob the wealth of ordinary people to give to the banks to lend to business to make their products for customers to buy with money devalued by printing.”

It is as ridiculous a circular proposition as perpetual motion, yet central banks never seem to question it. Monetary stimulus fails with every credit cycle when the destruction of wealth is exposed by rising prices. But in this credit cycle the deception was so obvious to the general public that it failed from the outset.

The last five years have seen all beliefs in the manageability of aggregate demand comprehensively demolished by experience. The unfortunate result of this failure is that central bankers now see no alternative to maintaining things as they are, because the financial system has become horribly over-geared and probably wouldn’t survive the rise in interest rates a genuine economic recovery entails anyway. Price inflation would almost certainly rise well above the 2% target forcing central banks to raise interest rates, throwing bonds and stocks into a severe bear market, and imperilling government finances. The financial system is simply too highly geared to survive a credit-driven recovery.

Japan, which has accelerated monetary debasement of the yen at an unprecedented rate, finds itself in this trap. If anything, the pace of its economic deterioration is increasing. The explanation is simple and confirms the obvious: monetary debasement impoverishes ordinary people. Far from boosting the economy it is rapidly driving us into a global slump.

The solution is not higher wages.