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Economics

Did “The Nixon Shock” Lead to Nixon’s Resignation?

This month we observe the 40th anniversary of the resignation, under threat of imminent impeachment, of President Richard M. Nixon.  Nixon aide and loyalist Pat Buchanan sums up, in a column in USA Today Liberal Elites Toppled Nixon his view: “Richard Nixon was not brought down by any popular uprising. The breaking of his presidency was a product of the malice and collusion of liberal elites who had been repudiated in Nixon’s 49-state landslide in 1972.”

Nixon, as it happens, was not 1974’s only casualty.  As William Safire recalls, Nixon’s secretary of the treasury, John Connally, “was indicted for taking graft on the same day the President was charged by the House Judiciary Committee for abuse of power.”

Both men were instrumental in the repudiation of the Bretton Woods gold-dollar monetary system that had undergirded post-war American (and world prosperity).  Bretton Woods, indeed, was coming apart (as a gold+paper pastiche standard inevitably is prone to do).  A gold-based international monetary order called out, however, to be mended not ended.  Nixon ended it.

The House Judiciary Committee’s charges and the Connally indictment uncannily fulfill a prophecy by Tom Paine.  Paine’s Common Sense triggered the American Revolution.  Paine later wrote a tract, Dissertations On Government; The Affairs of the Bank; and Paper Money in 1786. It was issued the year before the Constitutional Convention that would send the confederated former colonies into the epic called the United States of America.  It was, in part, a perfect diatribe against paper-based (rather than gold or silver defined) money.

Paine observed:

But the evils of paper money have no end.  Its uncertain and fluctuating value is continually awakening or creating new schemes of deceit. Every principle of justice is put to the rack, and the bond of society dissolved: the suppression, therefore; of paper money might very properly have been put into the act for preventing vice and immorality.

As to the assumed authority of any assembly in making paper money, or paper of any kind, a legal tender, or in other language, a compulsive payment, it is a most presumptuous attempt at arbitrary power.  There can be no such power in a republican government: the people have no freedom, and property no security where this practice can be acted: and the committee who shall bring in a report for this purpose, or the member who moves for it, and he who seconds it merits impeachment, and sooner or later may expect it.

Of all the various sorts of base coin, paper money is the basest.  It has the least intrinsic value of anything that can be put in the place of gold and silver.  A hobnail or a piece of wampum far exceeds it.  And there would be more propriety in making those articles a legal tender than to make paper so.

The laws of a country ought to be the standard of equity, and calculated to impress on the minds of the people the moral as well as the legal obligations of reciprocal justice.  But tender laws, of any kind, operate to destroy morality, and to dissolve, by the pretense of law, what ought to be the principle of law to support, reciprocal justice between man and man: and the punishment of a member who should move for such a law ought to be death.

The death penalty for proposing paper money? Paine called for the criminal indictment as a capital crime, and for impeachment, of any who even would call for tender laws.

Connally was acquitted on the charges of graft and perjury.  Later he underwent bankruptcy before dying in semi-disgrace.  Nixon resigned rather than undergoing impeachment, also living out his life in disgraced political exile.   The spirit of Paine’s declaration was fulfilled in both cases. Connally and Nixon engineered this violation, abandoning the good, precious-metal, money contemplated by the Constitution. Nemesis followed hubris.

The closing of the “gold window” was based, by Connolly, on deeply wrong premises.  It was sold to the public, by Nixon, on deeply false promises.

On August 15, 1971 President Nixon came before the American people to announce:

We must protect the position of the American dollar as a pillar of monetary stability around the world.

In the past 7 years, there has been an average of one international monetary crisis every year. Now who gains from these crises? Not the workingman; not the investor; not the real producers of wealth. The gainers are the international money speculators. Because they thrive on crises, they help to create them.

In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy–and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators.

I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.

Now, what is this action–which is very technical–what does it mean for you?

Let me lay to rest the bugaboo of what is called devaluation.

If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.

The effect of this action, in other words, will be to stabilize the dollar.

Now, this action will not win us any friends among the international money traders. But our primary concern is with the American workers, and with fair competition around the world.

To our friends abroad, including the many responsible members of the international banking community who are dedicated to stability and the flow of trade, I give this assurance: The United States has always been, and will continue to be, a forward-looking and trustworthy trading partner. In full cooperation with the International Monetary Fund and those who trade with us, we will press for the necessary reforms to set up an urgently needed new international monetary system. Stability and equal treatment is in everybody’s best interest. I am determined that the American dollar must never again be a hostage in the hands of international speculators.

Nixon’s promise that “your dollar will be worth just as much tomorrow as it is today” has, of course, completely falsified.  The 2014 dollar is worth only 15 cents in 1971 terms, buying 85% less than it did in 1971.   Some bugaboo.  All of Nixon’s other rationalizations for going off gold also have been falsified.

The closing of the gold window turned out to be the slamming of the golden door to social mobility and equitable prosperity.  In the wake of the closing of the gold window median family income stagnated, never again experiencing secular recovery.  Meanwhile the income of the wealthy has continued apace.  This has produced the very income inequality so loudly denounced by progressives who, ironically, are the last defenders of the very policy which is the probable cause of our inequitable prosperity.

Brother Pat Buchanan states that Nixon

…ended the Vietnam War with honor, brought all our troops and POWs home, opened up China, negotiated historic arms agreements with Moscow, ended the draft, desegregated southern schools, enacted the 18-year-old vote, created the EPA, OSHA and National Cancer Institute, and was rewarded by a grateful nation with a 61% landslide.

Even as Watergate broke, he ordered the airlift that saved Israel in the Yom Kippur War, for which Golda Meir called him the best friend Israel ever had.

His enemies were beside themselves with rage and resentment.

Buchanan, while admirably loyal, ignores the correlation between Nixon’s embrace of paper money and Paine’s prophetic call for impeachment for that high crime.  Let us now, in this month of the 40th anniversary of Nixon’s resignation and the 43rd of his abandonment of the gold standard, pause to wonder.  It is bewildering circumstance that the very liberal elites Buchanan indicts as malicious in their treatment of Nixon today represent the most reactionary of defenders of the most pernicious, and only enduring, residue of the Nixon Shock:  paper money, “a most presumptuous attempt at arbitrary power.”

Originating at http://www.forbes.com/sites/ralphbenko/2014/08/18/pat-buchanan-ignores-the-underlying-reason-richard-nixon-was-forced-to-resign/

Economics

John Butler’s interview with Jim Rickards

When it comes to the world of international finance, Jim Rickards has quite nearly seen it all. As a young man, he worked for Citibank in Pakistan, of all places. In the 1990s, he served as General Counsel for Long-Term Capital Management, Jim Merriwether’s large, notorious hedge fund that collapsed spectacularly in 1998. In recent years, he has been a regular participant in Pentagon ‘wargames’, in particular those incorporating financial or currency warfare in some way, and he has served as an advisor to the US intelligence community.

Yet while his experiences are vast in breadth, they have all occurred within the historically narrow confines of a peculiar international monetary regime, one lacking a gold- or silver-backed international reserve currency. Yes, reserve currencies have come and gone through history, but it is the US dollar, and only the US dollar, that has ever served as an unbacked global monetary reserve.

Nevertheless, in CURRENCY WARS and THE DEATH OF MONEY, Jim does an excellent job of exploring pertinent historical parallels to the situation as it exists today, in which the international monetary regime has been critically undermined by a series of crises and flawed policy responses thereto. He also applies not only economic but also complexity theory to provide a framework and deepen understanding.

As for what happens next, he does have a few compelling ideas, as we explore in the following pages. To begin, however, we explore what it was that got him interested in international monetary relations in the first place.

 

BACK TO THE 1970S: THE DECADE OF DISCO AND DOLLAR CRISES

JB: Jim, you might recall the rolling crises of the 1970s, beginning with the ‘Nixon Shock’ in 1971, when the US ‘closed the gold window’, to the related oil shocks and then the de facto global ‘run on the dollar’ at the end of the decade. At the time, as a student, did you have a sense as to what was happening, or any inclination to see this as the dollar’s first real test as an unbacked global monetary reserve? Did these events have any influence on your decision to study international economics and to work in finance?

 

JR: I was a graduate student in international economics in 1972-74, and a law student from 1974-77, so my student years coincided exactly with the most tumultous years of the combined oil, inflation and dollar crises of the 1970s. Most observers know that Nixon closed the gold window in 1971, but that was not considered the end of the gold standard at the time. Nixon said he was ‘temporarily’ suspending convertibility, but the dollar was still officially valued at 1/35th of an ounce of gold. It was not until 1975 that the IMF officially demonitised gold although, at French insistence, gold could still be counted as part of a country’s reserve position. I was in the last class of students who were actually taught about gold as a monetary asset. Since 1975, any student who learns anything about gold as money is self-taught because it is no longer part of any economics curriculum. During the dark days of the dollar crisis in 1977, I spoke to one of my international law professors about whether the Deutschemark would replace the dollar as the global reserve currency. He smiled and said, “No, there aren’t enough of them.” That was an important lesson in the built-in resilience of the dollar and the fact that no currency could replace the dollar unless it had a sufficiently large, liquid bond market – something the euro does not yet have to this day. From law school I joined Citibank as their international tax counsel. There is no question that my academic experiences in a period of borderline hyperinflation and currency turmoil played a powerful role in my decision to pursue a career in international finance.

 

JB: As you argued in CURRENCY WARS and now again in THE DEATH OF MONEY, the US debt situation, public and private, is now critical. It would be exceedingly difficult for another Paul Volcker to arrive at the Federal Reserve and shore up confidence in the system with high real interest rates. But why has it come to this? Why is it that the ‘power of the printing press’ has been so abused, so corrupted? Is this due to poor federal governance, as David Stockman argues in THE GREAT DEFORMATION? Is it due to the incompetence or ignorance of the series of Federal Reserve officials who failed to appreciate the threat of global economic imbalances? Or is it due perhaps to a fundamental flaw in the US economic and monetary policy regime itself?

 

JR: It is still possible to strengthen the dollar and cement its position as the keystone of the international financial system, but not without costs. Reducing money printing and raising interest rates would strengthen the dollar, but they would pop the asset bubbles in stocks and housing that have been re-created since 2009. This would also put the policy problem in the laps of Congress and the White House where it belongs. The problems in the economy today are structural, not liquidity-related. The Fed is trying to solve structural problems with liquidity solutions. That will never work, but it might destroy confidence in the dollar in the process. Federal Reserve officials have misperceived the problem and misapprehend the statistical properties of risk. They are using equilbirium models in a complex system. (Ed note: Complexity Theory explores the fundamental properties of dynamic rather than equilibrium systems and how they react and adapt to exogenous or endogenous stimuli.) That is also bound to fail. Fiat money can work but only if money issuance is rule-based and designed to maintain confidence. Today’s Fed has no rule and is destroying confidence. Based on present policy, a complete loss of confidence in the dollar and a global currency crisis is just a matter of time.

 

JB: Thinking more internationally, the dollar is in quite good company. ‘Abenomics’ in Japan appears to have failed to confer any meaningful, lasting benefits and has further undermined what little confidence was left in the yen; China’s bursting credit and investment bubble threatens the yuan; the other BRICS have similar if less dramatic credit excess to work off; and while the European Central Bank and most EU fiscal authorities have been highly restrained for domestic political reasons in the past few years, there are signs that this may be about to change. Clearly this is not a situation in which countries can easily trust one another in monetary matters. But as monetary trust supports trust in trade and commerce generally, isn’t it just a matter of time before the currency wars of today morph into the trade wars of tomorrow? And wouldn’t a modern-day Smoot-Hawley be an unparalleled disaster for today’s globalised, highly-integrated economy?

 

JR: Currency wars can turn into trade wars as happened in the 1920s and 1930s. Such an outcome is certainly possible today. The root cause is lack of growth on a global basis. When growth is robust, large countries don’t care if smaller trading partners grab some temporary advantage by devaluing their currencies. But when global growth in anemic, as it is now, a positive sum game becomes a zero-sum game and trading partners fight for every scrap of growth. Cheapening your currency, which simultaneously promotes exports and imports inflation via the cross rate mechanism, is a tempting strategy when there’s not enough growth to go around. We are already seeing a twenty-first century version of Smoot-Hawley in the form of economic sanctions imposed on major countries like Iran and Russia by the United States. This has more to do with geopolitics than economics, but the result is the same – reduced global growth that makes the existing depression even worse.

 

JB: You may recall that, in my book, THE GOLDEN REVOLUTION, I borrow your scenario of how Russia could, conceivably, undermine the remaining international trust in the dollar with a pre-emptive ‘monetary strike’ by backing the rouble with gold. Do you regard the escalating situation in Ukraine, as well as US policies in much of the Black Sea/Caucasus/Caspian region generally, as a potential trigger for such a move?

 

JR: There is almost no possibility that either the Russian rouble or the Chinese yuan can be a global reserve currency in the next ten years. This is because both Russia and China lack a good rule or law and a well-developed liquid bond market. Both things are required for reserve curreny status. The reason Russia and China are acquiring gold and will continue to do so is not to launch a new gold-backed currency, but rather to hedge their dollar positions and reduce their dependence on dollar reserves. If there is a replacement for the dollar as the leading reserve currency, it will either be the euro, the special drawing right (SDRs), or perhaps a new currency devised by the BRICS.

 

JB: Leaving geo-politics aside for the moment, you mention right at the start of THE DEATH OF MONEY, citing the classic financial thriller ROLLOVER, that even non-state actors could, perhaps for a variety of reasons, spontaneously begin to act in ways that, given the fragility of the current global monetary order, cascade into a run on the dollar and rush to accumulate gold. If you were to do a remake of ROLLOVER today, how would you structure the plot? Who could be the first to begin selling dollars and accumulating gold? Who might join them? What would be the trigger that turned a trickle of dollar selling into a flood? How might the US government respond?

 

JR: If Rollover were re-made today, it would not be a simple Arab v. US monetary plot. The action would be multilateral including Russia, China, Iran, the Arabs and others. Massive dumping of dollars might be the consequence but it would not be the cause of the panic. A more likely scenario is something entirely unexpected such as a failure to deliver physical gold by a major gold exchange or dealer. That would start panic buying of gold and dumping of dollars. Another scenario might begin with a real estate collapse and credit crash in China. That could cause a demand shock for gold among ordinary Chinese investors, which would cause a hyperbolic price spike in gold. A rising gold price is just the flip side of a collapsing dollar.

 

JB: This entire discussion all follows from the fragility of the current international monetary system. Were the system more robust, we could leave the dollar crisis topic to Hollywood for entertainment rather than to treat it with utmost concern for personal, national or even international security. But what is it that makes systems fragile? Authors ranging from George Gilder (KNOWLEDGE AND POWER), to Joseph Tainter (THE COLLAPSE OF COMPLEX SOCIETIES) and even Edward Gibbon (THE RISE AND FALL OF THE ROMAN EMPIRE) have applied such thinking to ancient and modern economies and societies. They all conclude that, beyond a certain point, centralisation of power is destabilising. Does this mean that a robust monetary system would ‘de-centralise’ monetary power? Isn’t this incompatible with any attempt by the G20 and IMF to transform the Special Drawing Right (SDR) from a unit of account into a centrally-managed, global reserve currency?

 

JR: Yes. Complex systems collapse because increases in complexity require exponential increases in energy to maintain the system. Energy can take many forms including money, which can be thought of as a form of stored energy. We are already past the point where there is enough real money to support the complexity of the financial system. Elites are now resorting to psuedo-money such as deriviatives and other forms of leverage to keep the system going but even that will collapse in time. The proper solution is to reduce the complexity of the system and restore the energy/money inputs to a sustainable level. This means reducing leverage, banning most derivatives and breaking up big banks. None of this is very likely because it cuts against the financial interests of the power elites who run the system. Therefore a continued path toward near-term collapse is the most likely outcome.

 

JB: In CURRENCY WARS you make plain that, although you are highly critical of the current economic policy mainstream for a variety of reasons, you are an agnostic when it comes to economic theory. Yet clearly you draw heavily on economists of the Austrian School (eg Hayek) and in THE DEATH OF MONEY you even mention the pre-classicist and proto-Austrian Richard Cantillon. While I doubt you are a closet convert to the Austrian School, could you perhaps describe what it is about it that you do find compelling, vis-à-vis the increasingly obvious flaws of current, mainstream economic thinking?

 

JR: There is much to admire in Austrian economics. Austrians are correct that central planning is bound to fail and free markets produce optimal solutions to the problem of scarce resources. Complexity Theory as applied to capital markets is just an extension of that thinking with a more rigorous scientific foundation. Computers have allowed complexity theorists to conduct experiments that were beyond the capabilities of early Austrians. The results verify the intuition of the Austrians, but frame the issue in formal mathematical models that are useful in risk management and portfolio allocation. If Ludwig von Mises were alive today he would be a complexity theorist.

 

JB: You may have heard the old Irish adage of the young man, lost in the countryside, who happens across an older man and asks him for directions to Dublin, to which the old man replies, unhelpfully, “Well I wouldn’t start from here.” If you were tasked with trying, as best you could, to restore monetary stability to the United States and by extension the global economy, how would you go about it? You have suggested devaluing the dollar (or other currencies) versus gold to a point that would make the existing debt burdens, public and private, credibly serviceable. But does this solve the fundamental systemic problem? What is to stop the US and global economy from printing excessive money and leveraging up all over again, and in a decade or two facing the same issues, only on a grander scale? Is there a better system? Could a proper remonetisation of gold a la the classical gold standard do the trick? Might there be a role for new monetary technology such as cryptocurrency?

 

JR: The classic definition of money involves three functions: store of value, medium of exchange and unit of account. Of these, store of value is the most important. If users have confidence in value then they will accept the money as a medium of exchange. The unit of account function is trivial. The store of value is maintained by trust and confidence. Gold is an excellent store of value because it is scarce and no trust in third parties is required since gold is an asset that is not simultaneously the liability of another party. Fiat money can also be a store of value if confidence is maintained in the party issuing the money. The best way to do that is to use a monetary rule. Such rules can take many forms including gold backing or a mathematical formula linked to inflation. The problem today is that there is no monetary rule of any kind. Also, trust is being abused in the effort to create inflation, which is form of theft. As knowledge of this abuse of trust becomes more widespread, confidence will be lost and the currency will collapse. Cryptocurrencies offer some technological advantages but they also rely on confidence to mainatin value and, in that sense, they are not an improvement on traditional fiat currencies. Confidence in cryptocurrencies is also fragile and can easily be lost. It is true that stable systems have failed repeatedly and may do so again. The solution for individual investors is to go on a personal gold standard by acquiring physical gold. That way, they will preserve wealth regardless of the monetary rule or lack thereof pursued by monetary authorities.

 

JB: Thanks Jim for your time. I’m sure it is greatly appreciated by all readers of the Amphora Report many of whom have probably already acquired a copy of THE DEATH OF MONEY.

 

POST-SCRIPT

In a world of rapidly escalating crises in several regions, all of which have a clear economic or financial dimension, Jim’s answers to the various questions above are immensely helpful. The world is changing rapidly, arguably more rapidly that at any time since the implosion of the Soviet Union in the early 1990s. Yet back then, the changes had the near-term effect of strengthening rather than weakening the dominant US position in global geopolitical, economic and monetary affairs. Today, the trend is clearly the opposite.

Jim’s use of Complexity Theory specifically is particularly helpful, as the balance of power now shifts away from the US, destabilising the entire system. Were the US economy more robust and resilient, perhaps a general global rebalancing could be a gradual and entirely peaceful affair. But with the single most powerful actor weakening not only in relative but arguably in absolute terms, for structural reasons Jim explains above, the risks of a disorderly rebalancing are commensurately greater.

The more disorderly the transition, however, the less trust will exist between countries, at least for a time, and as Jim points out it is just not realistic for either the Russian rouble or Chinese yuan to replace the dollar any time soon. As I argue in THE GOLDEN REVOLUTION, this makes it highly likely that as the dollar’s share of global trade declines, not only will other currencies be competing with the dollar; all currencies, including the dollar, will increasingly be competing with gold. There is simply nothing to prevent one or more countries lacking trust in the system to demand gold or gold-backed securities of some kind in exchange for exports, such as oil, gas or other vital commodities.

Jim puts the IMF’s SDR forward as a possible alternative, but here, too, he is sceptical there is sufficient global cooperation at present to turn the SDR into a functioning global reserve currency. The world may indeed be on the path to monetary collapse, as Jim fears, but history demonstrates that collapse leads to reset and renewal, and in this case it seems more likely that not that gold will provide part of the necessary global monetary foundation, at least during the collapse, reset and renewal period. Once trust in the new system is sufficient, perhaps the world will once again drift away from gold, and perhaps toward unbacked cryptocurrencies such as bitcoin, but it seems unlikely that a great leap forward into the monetary unknown would occur prior to a falling-back onto what is known to have provided for the relative monetary and economic stability that prevailed prior to the catastrophic First World War, which as readers may note began 100 years ago this month.

 

Economics

Signs Of The Fed’s Era Of Secrecy Coming To An End

The Federal Reserve increasingly is attracting scrutiny across the board.  Now add to that a roller coaster of a thriller, using a miracle of a rare device, shining a light into the operations of the Fed — that contemporary riddle wrapped in a mystery inside an enigma: Matthew Quirk’s latest novel, The Directive.

“If I’ve made myself too clear, you must have misunderstood me,” Fed Chairman Alan Greenspan once famously said.  The era of a mystagogue Fed may be ending.  Recently, the House Government Oversight Committee passed, and referred to the full House, theFederal Reserve Transparency Act of 2014.  This legislation is part of the legacy of the great former Representative Ron Paul.  It popularly is known as “Audit the Fed.” How ironic that a mystery novel proves a device to dispel some of the Fed’s obscurantist mystery.

Novelist/reporter Matthew Quirk’s The Directive does for he Fed what Alan Drury did for Senate intrigue with his Pulitzer Prize winning Advise and Consent, what Aaron Sorkin did for the White House in The West Wing and, now, what Beau Willimon, is doing for the Congress with House of Cards.  Quirk takes the genre of political thriller into virgin territory: the Fed. Make to mistake.  Engaging the popular imagination has political potency.  As Victor Hugo, nicely paraphrased, observed: Nothing is as powerful as an idea whose time has come.

Quirk, according to his website,“studied history and literature at Harvard College. After graduation, he spent five years at The Atlantic reporting on crimes, private military contractors, the opium trade, terrorism prosecutions, and international gangs.”  His background shows. Quirk’s writings drips with the kind of eye for the telling detail that only a canny reporter, detective, or spy possesses.  (Readers will learn, just in passing, the plausible identity of the mysterious “secure undisclosed location” where the vice president was secreted following 9/11.)

If you like Ludlum you are certain to like Quirk.  And who isn’t intrigued by such a mysteriously powerful entity as the Fed?  Booklist calls The Directive a “nonstop heart-pounding ride in which moral blacks and whites turn gray in the ‘efficient alignment of power and interests’ that is big time politics.”  Amen.

The Directive describes an effort to rob the biggest bank in the world.  The object of the heist is not the tons of gold secured in the basement of 33 Liberty Street. (As Ian Fleming pointed out, in Goldfinger it logistically is impossible to move the mass of so much gold quickly enough to effect a robbery.)  Rather, Quirk uses as his literary device, with a touch of dramatic license, the interception of the Federal Open Market Committee’s directive to the trading desk of the Federal Reserve Bank of New York to raise (or lower) interest rates in order to use that insider information to make a fast killing.

Lest anyone doubt the power of such insider information consider William Safire’s report, from his White House classic memoir Before the Fall, of the weekend at Camp David before Nixon “closed the gold window.”

After the Quadriad meeting, the President remained alone while the rest of the group dined at the Laurel Cabin.   The no-phone-calls edict was still in force, raising some eyebrows of men who had shown themselves to be trustworthy repositories of events. but the 6’8″, dour Treasury Under Secretary Volcker explained a different dimension to the need for no leaks:  “Fortunes could be made with this information.”  Haldeman, mock-serious, leaned forward and whispered loudly, “Exactly how?”  The tension broken, Volcker asked Schulz, “How much is your budget deficit?”  George estimated, “Oh, twenty three billion or so — why?”  Volcker looked dreamily at the ceiling.  “Give me a billion dollars and a free hand on Monday, and I could make up that deficit in the money markets.”

Safire provides context making Volcker’s integrity indisputable lest anyone be tempted to misinterpret this as a trial balloon.

This columnist has been inside the headquarters of the Fed, including, many years ago, the boardroom.  Quirk:

Every eight weeks or so, a committee gathers near the National Mall in a marble citadel known as the Board of Governors of the Federal Reserve.  Twenty-five men and women sit at a long wooden table with an inset of black stone shined to a high gloss.  By noon they decide the fate of the American economy.

This columnist never has stepped foot inside the Federal Reserve Bank of New York, much less its trading floor(s).  Few have entered that sanctum sanctorum.  By taking his readers inside Quirk provides his readers a narrative grasp to how the Fed does what it does.

Quirk:

[T]he Fed is by design very friendly to large New York banks.  When the committee in DC decides what interest rates should be, they can’t simply dictate them to the banks.  They decide on a target interest, and then send the directive to the trading desk at the New York Fed to instruct them about how to achieve it.  The traders upstairs go into the markets and wheel and deal with the big banks, buying and selling Treasury bills and other government debts, essentially IOUs from Uncle Sam.  When the Fed buys up a lot of those IOUs, they flood the economy with money; when they sell them, they take money out of circulation.

They are effectively creating and destroying cash.  By shrinking or expanding the supply of money in the global economy, making it more or less scarce, they also make it more or less expensive to borrow; the interest rate.  In this way, trading back and forth with the largest banks in the world, they can drive interest rates toward their target.

The amount of actual physical currency in circulation is only a quarter of the total monetary supply.  The rest is just numbers on a computer somewhere.  When people say the government can print as much money as it wants, they’re really talking about the desk doing its daily work of resizing the monetary supply—tacking zeros onto a bunch of electronic accounts—that big banks are allowed to lend out to you and me.

***

Every morning, on the ninth floor of the New York Fed, the desk gets ready to go out and manipulate the markets according to the instructions laid out in the directive.  Its traders are linked by computer with twenty-one of the largest banks in the world.  When they’re ready to buy and sell, in what are called open market operation, one trader presses a button on his terminal and three chimes — the notes F-E-D — sound on the terminals of his counterparties.  Then they’re off to the races.

There are usually eight to ten people on that desk, mostly guys in their late twenties and early thirties, and they manage a portfolio of government securities worth nearly $4 trillion that backs our currency.  Without it, the bills in your wallet would be as worthless as Monopoly cash.  The traders on that floor carry out nearly $5.5 billion in trades per day, set the value of every penny you earn or spend, and steer the global economy.

As Quirk recently told Matthew Yglesias, at Vox.com:

I was casting about for the biggest hoards of money in the world, and you get to the Federal Reserve Bank in New York fairly quickly. But that’s been done. Then I learned more and more about the trading desk, and my mind was blown.

You get to have this great line where you say, “There’s $300 billion worth of gold in the basement, but the real money is on the ninth floor.” …

I was a reporter in Washington for a while, and I thought, “Oh, the Fed sets interest rates,” because that’s always what people say. But as you dig into it, you realize that the Fed just has to induce interest rates to where they want to be. They have to trade back and forth with these 19 or 20 banks, and they have 8‑10 guys at this trading desk, trading about $5.5 billion a day. That’s actually how the government prints money and expands and contracts the monetary supply.

It’s this high wire act. You explain it to people and they say, “Oh, it’s a conspiracy thriller.” You say, “No, no. That’s the real part. I haven’t gotten to the conspiracy yet.” But it’s a miracle that it works.

Quirk’s own dual mandate? Combine fast-paced drama with a peek behind the scenes of the world’s biggest bank, providing vivid entertainment while teaching more about the way that one of the most powerful and mysterious institutions in the world works. In The Directive Matthew Quirk shakes, rather than stirs, his readers brilliantly.

Originating at Forbes.com: http://www.forbes.com/sites/ralphbenko/2014/08/04/signs-of-the-feds-era-of-secrecy-coming-to-an-end/

Economics

How to Start Reforming the Federal Reserve Right Now

[Editor's Note: this piece, by Brendan Brown, was first published at mises.org]

First the good news. The House Financial Services Committee has held a hearing on “Legislation to Reform the Federal Reserve on its 100-year Anniversary.” The hearing focused on a bill introduced by Scott Garrett and Bill Huizenga which would require the Fed to provide Congress with a clear rule to describe the course of monetary policy. Now for the bad news. The rule is to be an equation showing how the Fed would adjust interest rates in response to changes in certain economic variables. And the star witness before the committee proposing his own version of such a rule is renowned neo-Keynesian economist, ex-Bush official Professor John B. Taylor.

Inputs into the so-called “Taylor Rule” involve key magnitudes such as “the neutral rate of interest” and “the natural rate of unemployment” as well as the “targeted rate of inflation.” One might have hoped that the Republicans by now would have realized that monetary reform should involve first and foremost jettisoning neo-Keynesian economics. Even the most talented Fed official cannot know the neutral level of interest rates (whether for short, medium, or long maturities) or the natural level of unemployment. And as to inflation targets, these should be scrapped in any monetary reform and replaced by the aim of monetary stability broadly defined to include absence of asset price inflation and a very long-run stable anchor to goods and services prices.

First, Set Interest Rates Free

An essential component of monetary reform should be setting interest rates free. This means no more official pegging or guidance of short-term interest rates and no attempt to manipulate in various ways long-term interest rates. Markets can do a better job of discovering the neutral rates of interest (across different maturities) and positioning market rates at any time relative to these so as to guide the economy along an equilibrium path than any set of well-informed and even well-meaning Fed officials. This is all on the big assumption that the reformers can design a monetary system around a suitable firmly placed pivot.

Under the gold standard the pivot was a fixed price for gold alongside the widespread use of gold coins. And so the amount of high-powered money in the world grew in line with the above ground stock of yellow metal, which occurred at a glacial, but flexible pace. The demand for high-powered money was itself a fairly stable function of income and wealth. And so the system was well-anchored. Yes, there were imperfections, including the advent of fractional-reserve banking which meant that the demand for high-powered money became less stable. Yet given the absence of deposit insurance and too-big-to-fail and only limited lender of last resort roles banks could be counted upon to have a strong demand for reserves (mainly in the form of gold) to back their deposits. Moreover the obligation to convert customers’ deposits into gold coin on request buttressed this demand for high powered money from the banks.

More Steps Toward Proper Reform

As a matter of practical politics the Republican Congressmen may well conclude that an imminent return to gold is unfeasible. But they could consider in the light of these considerations how best to re-secure the pivot to the US monetary system by creating high-powered money for which demand would be stable and the rate of increase in supply flexibly very low. The steps toward this end would include:

· Abolishing the payment of interest on bank reserves.

· Strict curtailment of lender of last resort function.

· Long-term abolition of deposit insurance.

· Fed withdrawal from creating liquidity in debt markets (no more eligible bills, repo-transactions, etc.).

· Issuance of large-denomination notes (adding to the demand for currency, a key component of high-powered money).

· A legal attack on monopoly power in the credit card business which results often in payers of cash not enjoying a discount.

In this suitably reformed system there would be a huge demand for high-powered money (whether in the form of currency or reserves held by the banks) highly distinct in function from any alternative assets. This demand would not depend on legislating artificially high reserve requirements which bank lobbyists would surely whittle down over time. That was the Achilles heel of the briefly successful monetarist experiment in Germany during the 1970s and early 1980s, as the bankers were finally able to bring political pressure toward lowering reserve requirements such that monetary base no longer was a secure pivot to the monetary system. Accordingly, the Bundesbank gradually shifted to explicit pegging of short-term interest rates albeit subject to a medium-term target for wider money supply growth.

Turning back to the US, even with the reforms suggested, there would still be the difficult question of how to determine the growth in supply of high-powered money. Without a gold connection there has to be some degree of discretionary control in this process, albeit constrained by a quantitative guide (such as an average 1 to 1.5-percent rate of expansion per annum, similar to the expansion rate of above ground gold over the past century) and ultimately constitutionally-embedded legal restrictions.

High-powered money as defined by such a monetary reform would be a far cry from the present situation where the size of the Federal Reserve balance sheet has been recording explosive growth for many years and where the main form of high-powered money, excess reserves, pays interest at above the market rate to the banks. The Republicans in their pursuance of monetary reform would do well to propose some initial steps which would prepare the way for bolder change at a later date with the aim of creating a stable supply and demand for high-powered money.

A key step would be the immediate suspension of interest payments on reserves (which only started in 2008) coupled with a rapid timetable for disposing of the Fed’s massive portfolio of long-term fixed-rate bonds. The Bernanke Fed, and now the Yellen Fed, has used this portfolio as a means of manipulating long-term interest rates (with this depending on an emperor’s new clothes effect whereby markets attach unquestioning importance to the Fed’s massive holdings in forming their expectations of bond prices) and of scaring investors into real assets so adding to the strength of their asset price inflation virus injections.

One suggestion for a rapid timetable would be the Treasury and Fed entering into a deal in which the long-term fixed-rate T-bonds held by the Fed would be converted into long-term floating rate debt and into short- or medium-term T-bills. This would mean less accounting profit under the present structure of yields for the Fed and a lower cost of borrowing for the Treasury. But who really cares about such bookkeeping between the federal government and its monetary agency? In turn the Treasury would announce a long-term timetable for raising the ratio of long-maturity fixed to floating rate debt in the overall total outstanding.

Rome was not made in a day. And the Republicans are certainly not in a position to legislate radical monetary reform. But that is no excuse for a careless decision by the would-be reformers to veer into a cul-de-sac under the misleading directions of Professor Taylor.

Economics

Signs Of The Gold Standard Emerging From Great Britain?

Comes now to respectful international attention a volume entitled War and Gold: A 500-Year History of Empires, Adventures, and Debt by Member of Parliament Kwasi Kwarteng.  This near-perfect volume appears with almost preternaturally perfect timing around the centenary of the beginning of World War I and, with that, the end of the classical gold standard.  It, along with the work of Steve Baker, MP (co-founder of the Cobden Centre), constitutes a sign of sophistication about the gold standard in the British House of Commons.

Kwarteng, the most historically literary Member of Parliament since Churchill, is an impressive figure.  As War and Gold‘s jacket flap biography summarizes, “Kwasi Kwarteng was born in London to Ghanaian parents in 1975.  …  After completing a PhD in history at Cambridge University, he worked as a financial analyst in London.  He is a Conservative member of parliament and author of Ghosts of Empire: Britain’s Legacies in the Modern World.”  Kwarteng thus possesses four crucial skill sets: an international, multicultural, perspective; rigorous training as an historian; direct experience in the financial markets; and the perspective of an elected legislator.  It shows.

Kwasi Kwarteng MP at Global Growth: Challenge ...
Kwasi Kwarteng MP at Global Growth: Challenge or opportunity for the UK (Photo credit: Policy Exchange)

War and Gold is a compelling successor to Liaquat Ahamed’s delightful and invaluable The Lords of Finance, awarded the 2010 Pulitzer Prize in history. Kwarteng delivers up a successor volume worthy of such a prize.  It extends Ahamed’s temporal framework by a factor of ten, to 500 years. Kwarteng, too, has compelling narrative virtuosity.  His book is full of  dramatic, charming, often wry vignettes of fascinating characters — heroes and villains, adventurers and knaves — spinning around, and off, the axis of the gold standard, in war and in peace.

Let us pause to pay tribute to Kwarteng’s Ghanian ancestry.  Ghana, once known as the “Gold Coast,” was part of the Ashanti Empire. Ghana is a too-often overlooked gem of civilization.   The most iconic piece of Ashanti regalia, as described by Wikipedia, was a Golden Stool:

The Golden Stool is sacred to the Ashanti, as it is believed that it contains the Sunsum viz, the spirit or soul of the Ashanti people. Just as man cannot live without a soul, so the Ashanti would cease to exist if the Golden Stool were to be taken from them. The Golden Stool is regarded as sacred that not even the king was allowed to sit on it, a symbol of nationhood and unity.

War and Gold provides a literary symphony in four movements.

Its first movement commences with the story of the Holy Roman Emperor whose wars bankrupted his empire.  This is counterpoised with stories of rapacious Conquistadors, especially Pizzaro plundering the Inca for their gold, “the sweat of the sun,” and silver, “the tears of the moon.”

Kwarteng thereupon moves smartly to the military, political and economic skirmishing between France and England; the upheavals produced by the American and French revolutions and their aftermaths; the prosperity and stability of the Victorian era… and the rise of the United States.  Many of our economic challenges have a long pedigree.  The fundamental things don’t change as times goes by.

Its second movement, describing the epic era of the first World War, notes that this war destroyed the classical international gold standard.  Chapter 9, “World Crisis,” contains the only significant point of confusion in this otherwise masterful work: the attribution to the gold standard of the Great Depression.  That error is widespread.  It is a crucial mistake to dispel for the discourse to move forward.  Call it the Eichengreen Fallacy.

Prof. Eichengreen, author of Golden Fetters, was and remains non-cognizant of a subtle but crucial aspect of world monetary history — and, apparently, of the works of Profs. Jacques Rueff and Robert Triffin elucidating the implications.  Eichengreen blundered by attributing the Great Depression to the gold standard.  This, demonstrably, is untrue. That claim has led the discourse astray.

The classical gold standard, as Kwarteng points out, collapsed under the pressure of the first World War, long before the Great Depression.  The classical gold standard was suspended when the Depression hit.

An attempt was made to resuscitate the gold standard in Genoa, in 1922, putting in place what that great French classical liberal economist Jacques Rueff called “a grotesque caricature” of the gold standard: the gold-exchange standard.  Genoa authorized a deformed pastiche of gold and paper currency as official central bank reserve assets.

Genoa set up a system mistaken (then as now) as equivalent to the classical gold standard.  The inclusion of (gold-convertible) currencies as an official reserve asset for central banks thwarted the ability of the system to extinguish excess liquidity balances. This, due to an intrinsic moral hazard not fully grasped even by many gold standard proponents, led to a systemic inflation — increasing all commodities except, of course, as monetized, gold.  Key classical gold standard advocates, such as Rueff protégé Lewis E. Lehrman (with whose Institute this writer has a professional association), consider this the key cause of the Great Depression.

FDR did not, despite his grandiose declaration to that effect, end the gold standard.  FDR performed an appropriate and crucial revaluation of the dollar from $20.67/oz to $35/oz.  This was utterly needed to adjust for distortions caused by the inherent defect of the gold-exchange standard.

The revaluation worked and to stunning (if temporary, likely due to a subsequent Treasury decision to sterilize gold inflows as suggested by Calomiris, et al) effect.  As described by Ahamed:

But in the days after the Roosevelt decision, as the dollar fell against gold, the stock market soared by 15%.  Even the Morgan bankers, historically among the most staunch defenders of the gold standard, could not resist cheering.  ‘Your action in going off gold saved the country from complete collapse,’ wrote Russell Leffingwell to the president.

Taking the dollar off gold provided the second leg to the dramatic change in sentiment… that coursed through the economy that spring. … During the following three months, wholesale prices jumped by 45 percent and stock prices doubled.  With prices rising, the real cost of borrowing money plummeted. New orders for heavy machinery soared by 100 percent, auto sales doubled, and overall industrial production shot up 50 percent.

The dollar had not, in fact, been taken “off gold.”  As Kwarteng astutely notes, “The United States, as already stated, was still on gold, but it had devalued the dollar by over 50 per cent.”

Given Kwarteng’s current and, likely, future importance to the world monetary discourse it really would be invaluable were he to master the arguments of Jacques Rueff, and of Lewis Lehrman, as well as those of Triffin (who shared the same diagnosis while offering a different prescription).  It is important, for the long run, to recognize the innocence of the classical gold standard in the matter of the Great Depression and to grasp the insidious toxicity of the gold-exchange standard, which Rueff termed “an unbelievable collective mistake which, when people become aware of it, will be viewed by history as an object of astonishment and scandal.”

War and Gold’s third movement opens with America at its apogee:  “In 1945 the United States was by far the most powerful nation on earth.  It could also be argued that no nation has ever enjoyed such preponderant influence on the world’s affairs as did as the U.S. did at the close of the Second World War.”

Kwarteng then provides a vivid picture of an era in some ways nearly as distant as the 16th century. Quoting from a 1947 article in the Journal of Political Economy: “Some people are thinking in terms of only 18 or 20 billion dollars [of federal government spending] per year.  Others see a possibility that federal expenditures may run to 25 or 40 billions annually.” Uncle Sam lately spends over $10 billion per day.  While this sum is not adjusted for inflation or population growth, still it conveys a stunning difference of scale of government spending.

It is a pleasure to see the great Fed chairman William McChesney Martin given his due.  Kwarteng references a speech by the newly appointed Martin alluding to “the Frankenstein mechanics of an uncontrolled supply of money.”  If Frankenstein’s monster was an apt metaphor in the 1950s, surely Godzilla better fits the bill today.  “To be a sound money man was a moderately easy task for a Chairman of the Federal Reserve in the 1950s,” Kwarteng notes.  “The dollar, through the Bretton Woods Agreement, had preserved the all-important link to gold, which still held the almost magical value of US$35 an ounce.”

Kwarteng then presents a lucid presentation of post-war economic policies of Britain, Germany, and Japan.  This columnist took special pleasure in his resurrection of the role of unjustly obscure Joseph Dodge, a key architect of the resurrection of both Germany and Japan and who later balanced the budget of the Eisenhower administration.

Looping back to the United States, Kwarteng describes what might fairly be called the Götterdämmerung:

The final break with gold was dramatic and, as much as any other development of monetary system, can almost be entirely attributable to the action of one man, the President of the United States, Richard M. Nixon.  It was Nixon’s decision in August 1971 which substantially altered the course of monetary history and inaugurated a period, for the first time in 2,500 years, in which gold was effectively demonetized in most of what had been understood to be the Western world.

The world goes fast downhill from there.

The fourth movement delineates the chaos of, and various attempts to cope with, our current era of monetary anarchy.  He recounts the oil price shocks, Reagan and Thatcher, the creation of the Euro, the rise of China, the delusions of debt, and the emergence of crises and bailouts. He goes on to provide an epilogue on the Greek economic crisis and on precarious conditions in America. Kwarteng concludes:

Gold itself…remains embedded in the public’s consciousness as a monetary metal.  It is held most commonly by central banks and there remains an almost mysterious fixation with it.  Its value equally mysteriously can be reflected in the growth of the world economy. … [T]he value of gold, better than perhaps any currency, reflects this process most accurately.  The gold standard will never formally return, but movements in the price of gold may well suggest that investors, in their lack of faith in paper money, have informally adopted one.

Great Britain, and the world, hardly could be better served than by, in due course, elevating Kwarteng to the Exchequer. Notwithstanding his curious demurral that the “gold standard will never formally return,” gold, recovering from the false charge of blame for the Great Depression, slowly is becoming a fully respectable option.  Perhaps even, in the not too distant future, a movement to consider, and restore, the classical gold standard might be led by Kwasi Kwarteng and like-minded classical liberal-minded officials around the world.

Economics

New private monies can outcompete government monetary systems

[Editor's note: this article was originally published by the IEA here]

I would like to thank the IEA for today publishing my monograph, New Private Monies, which examines three contemporary cases of private monetary systems.

The first is the Liberty Dollar, a private mint operated by Bernard von NotHaus, whose currency became the second most widely used in the United States. It was highly successful and its precious metallic basis ensured it rose in value over time against the inflating greenback. In 2007, however, Uncle Sam shut it down, successfully charging von NotHaus with counterfeiting and sundry other offences. In reality, the Liberty Dollar was nothing like the greenback dollar. Nor could it be, as its purpose was to provide a superior dollar in open competition, not to pass itself off as the inferior dollar it was competing against, which has lost over 95 per cent of its value since the Federal Reserve was founded a century ago. For this public service of providing superior currency, Mr. von NotHaus is now potentially facing life in the federal slammer. As he put it:

‘This is the United States government. It’s got all the guns, all the surveillance, all the tanks, it has nuclear weapons, and it’s worried about some ex-surfer guy making his own money? Give me a break!’

The second case is e-gold, a private digital gold transfer business – a kind of private gold standard – run by Dr Doug Jackson out of Nevis in the Caribbean. By 2005, e-gold had risen to become second only to PayPal in the online payments industry. Jackson correctly argued that it was not covered by any existing US financial regulation, not just because of its offshore status but also because it was a payment system rather than a money transmitter or bank as then-defined, and not least because gold was not legally ‘money’. Yet despite its efforts to clarify its evolving regulatory and tax status, and despite helping them to catch some of the biggest cyber criminals then in operation, US law enforcement turned on the company: they trumped up charges of illegal money transmission and blackmailed its principals into a plea bargain.

Both these cases illustrate that there is a strong demand for private money and that the market can meet that demand and outcompete government monetary systems. Unfortunately, they also illustrate the perils of private money issuers operating out in the open where they are vulnerable to attack by the government. Perhaps they should operate undercover instead…

This takes us to the third case study: Bitcoin, a new type of currency known as crypto-currency, a self-regulating and highly anonymous computer currency based on the use of strong cryptography.

To quote its designer, Satoshi Nakamoto:

‘The root problem with conventional currency is all the trust that is required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust…

‘Bitcoin’s solution is to use a peer-to-peer network to check for double-spending…the result is a distributed system with no single point of failure.’

Bitcoin is produced in a kind of electronic ‘mining’ process, in which successful ‘miners’ are rewarded with Bitcoin. The process is designed to ensure that the amounts produced are almost exactly known in advance. Since its inception in 2009, the demand for Bitcoin has skyrocketed, albeit in a very volatile way, forcing its price from 3 cents to (currently) just under $600. Perhaps the best-known use of Bitcoin has been on the dark web drugs market Silk Road, the ‘Amazon.com of illegal drugs’, but Bitcoin is increasingly popular for all manner of mundane legal uses as well.

Bitcoin is a wonderful innovation, but the pioneers in any industry are rarely the ones who last. Despite Bitcoin’s success to date, it is doubtful whether being the first mover is an advantage in the longer term: design flaws in the Bitcoin model are set in concrete and competitors can learn from them. The crypto-currency market is also an open one and a considerable number of competitors have since entered the field. Most of these will soon fail, but no-one can predict which will be best suited to the market and achieve long-run success. Most likely, Bitcoin will eventually be displaced by even better crypto-currencies.

Crypto-currencies have momentous ramifications. As one blogger put it:

‘As long as my encrypted [Bitcoin] wallet exists somewhere in the world, such as on an email account, I can walk across national borders with nothing on me and retrieve my wealth from anywhere in the world with an internet connection.’

This gives Bitcoin great potential as an internationally mobile store of value that offers a high degree of security against predatory governments. Bitcoin now fulfils the role once met by bank secrecy – the ability to protect one’s financial privacy.

There is no easy way in which the government can prevent the use of Bitcoin to evade its control. The combination of anonymity and independence means that governments cannot bring Bitcoin down by taking out particular individuals or organisations because the system has no single point of failure. They could shut down whatever sites they like, but the Bitcoin community would carry on.

Strong cryptography therefore offers the potential to swing the balance of power back from the state toward the individual. Censorship, prohibition, oppressive taxes and repression are being undermined as people increasingly escape into the cyphersphere where they can operate free from government harassment.

We now face the prospect of a peaceful crypto-anarchic society in which there is no longer any government role in the monetary system and, hopefully, no government at all.

Welcome to crypto-anarchy.

 

New Private Monies: A Bit-Part Player can be downloaded here.

Economics

Keynesian madness: central banks waging war on price stability, savers

[Editor's note: This article also appears on Detlev Schlichter's blog here. It is reproduced with kind permission and should NOT be taken to be investment advice.]

There is apparently a new economic danger out there. It is called “very low inflation” and the eurozone is evidently at great risk of succumbing to this menace. “A long period of low inflation – or outright deflation, when prices fall persistently – alarms central bankers”, explains The Wall Street Journal, “because it [low inflation, DS] can cripple growth and make it harder for governments, businesses and consumers to service their debts.” Official inflation readings at the ECB are at 0.7 percent, still positive so no deflation, but certainly very low.

How low inflation cripples growth is not clear to me. “Very low inflation” was, of course, once known as “price stability” and used to invoke more positive connotations. It was not previously considered a health hazard. Why this has suddenly changed is not obvious. Certainly there is no empirical support – usually so highly regarded by market commentators – for the assertion that low inflation, or even deflation, is linked to recessions or depressions, although that link is assumed to exist implicitly or explicitly in the financial press almost daily. In the twentieth century the United States had many years of very low inflation and even outright deflation that were not marked by recessions. In the nineteenth century, throughout the rapidly industrializing world, “very low inflation” or even persistent deflation were the norm, and such deflation was frequently accompanied by growth rates that would today be the envy of any G8 country. To come to think of it, the capitalist economy with its constant tendency to increase productivity should create persistent deflation naturally. Stuff becomes more affordable. Things get cheaper.

“Breaking news: Consumers shocked out of consuming by low inflation!”

So what is the point at which reasonably low inflation suddenly turns into “very low inflation”, and thus becomes dangerous according to this new strand of thinking? Judging by the reception of the Bank of England’s UK inflation report delivered by Mark Carney last week, on the one hand, and the ridicule the financial industry piles onto the ECB on the other – “stupid” is what Appaloosa Management’s David Tepper calls the Frankfurt-based institution according to the FT (May 16) -, the demarcation must lie somewhere between the 1.6 percent reported by Mr. Carney, and the 0.7 that so embarrasses Mr. Draghi.

The argument is frequently advanced that low inflation or deflation cause people to postpone purchases, to defer consumption. By this logic, the Eurozonians expect a €1,000 item to cost €1,007 in a year’s time, and that is not sufficient a threat to their purchasing power to rush out and buy NOW! Hence, the depressed economy. The Brits, on the other hand, can reasonably expect a £1,000 item to fetch £1,016 in a year’s time, and this is a much more compelling reason, one assumes, to consume in the present. The Brits are in fact so keen to beat the coming 2 percent price hikes that they are even loading up on debt again and incur considerable interest rate expenses to buy in the here and now. “Britons are re-leveraging,” tells us Anne Pettifor in The Guardian, “Net consumer credit lending rose by £1.1bn in March alone. Total credit card debt in March 2014 was £56.9bn. The average interest rate on credit card lending, [stands at] at 16.86%.” Britain is, as Ms. Pettifor reminds us, the world’s most indebted nation.

I leave the question to one side for a minute whether these developments should be more reason to “alarm central bankers” than “very low inflation”. They certainly did not alarm Mr. Carney and his colleagues last week, who cheerfully left rates at rock bottom, and nobody called the Bank of England “stupid” either, to my knowledge. They certainly seem not to alarm Ms. Pettifor. She wants the Bank of England to keep rates low to help all those Britons in debt – and probably yet more Britons to get into debt.

Ms. Pettifor has a highly politicized view of money and monetary policy. To her this is all some giant class struggle between the class of savers/creditors and the class of spenders/debtors, and her allegiance is to the latter. Calls for rate hikes from other market commentator thus represent “certain interests,” meaning stingy savers and greedy creditors. That the policy could set up the economy for another crisis does not seem to trouble her.

Echoing Ms. Pettifor, Martin Wolf flatly stated in the FT recently that the “low-risk-seeking saver” no longer served a useful purpose in the global economy, and he approvingly quoted John Maynard Keynes with his call for the “euthanasia of the rentier”. “Interest today rewards no genuine sacrifice,” Keynes wrote back then, obviously in error: Just ask Britons today if not spending their money now but saving it for a rainy day does not involve a genuine sacrifice. Today’s rentiers do not even get interest for their sacrifices, thanks to all the “stimulus” policy. And now the call is for an end to price stability, for combining higher inflation with zero rates. It is not much fun being a saver these days – and I doubt that these policies will make anyone happy in the long run.

Euthanasia of the Japanese rentier

What the “euthanasia of the rentier” may look like we may have chance to see in Japan, an ideal test case for the policy given that the country is home to a rapidly aging population of life-long savers who will rely on their savings in old age. The new policy of Abenomics is supposed to reinvigorate the economy through, among other things, monetary debasement. “In as much as Abenomics was intended to generate strong nominal growth, I have been a big believer,” Trevor Greetham, asset allocation director at Fidelity Worldwide Investment, wrote in the FT last week (FT, May 15, 2014, page 28). “Japan has been in debt deflation for more than 20 years.”

Really? – In March 2013, when Mr. Abe installed Haruhiko Kuroda as his choice of Bank of Japan governor, and Abenomics started in earnest, Japan’s consumer price index stood at 99.4. 20 years earlier, in March 1994, it stood at 99.9 and 10 years ago, in March 2004, at 100.5. Over 20 years Japan’s consumer prices had dropped by 0.5 percent. Of course, there were periods of falling prices and periods of rising prices in between but you need a microscope to detect any broad price changes in the Japanese consumption basket over the long haul. By any realistic measure, the Japanese consumer has not suffered deflation but has enjoyed roughly price stability for 20 years.

“The main problem in the Japanese economy is not deflation, it’s demographics,” Masaaki Shirakawa declared in a speech at Dartmouth College two weeks ago (as reported by the Wall Street Journal Europe on May 15). Mr. Shirakawa is the former Bank of Japan governor who was unceremoniously ousted by Mr. Abe in 2013, so you may say he is biased. Never mind, his arguments make sense to me. “Mr. Shirakawa,” the Journal reports, “calls it ‘a very mild deflation’ [and I call it price stability, DS] that had the benefit of helping Japan maintain low unemployment.” The official unemployment rate in Japan stands at an eye-watering 3.60%. Maybe the Japanese have not fared so poorly with price stability.

Be that as it may, after a year of Abenomics it turns out that higher inflation is not really all it’s cracked up to be. Here is Fidelity’s Mr. Greetham again: “Things are not as straightforward as they were….The sales tax rise pushed Tokyo headline inflation to a 22-year high of 2.9 percent in April, cutting real purchasing power and worsening living standards for the many older consumers on fixed incomes.”

Mr. Greetham’s “older consumers” are probably Mr. Wolf’s “rentiers”, but in any case, these folks are not having a splendid time. The advocates of “easy money” tell us that a weaker currency is a boost to exports but in Japan’s case a weaker yen lifts energy prices as the country is heavily dependent on energy imports.

The Japanese were previously thought to not consume enough because prices weren’t rising fast enough, now they may not consume enough because prices are rising. The problem with going after “nominal growth” is that “real purchasing power” may get a hit.

If all of this is confusing, Fidelity’s Mr. Greetham offers hope. We may just need a bigger boat. More stimulus. “The stock market may need to get lower over the next few months before the government and Bank of Japan are shocked out of their complacency…When domestic policy eases further, as it inevitably will, the case for owning the Japanese market will be compelling once again.”

You see, that is the problem with Keynesian stimulus, you need to do ever more of it, and make it ever bigger, in an effort to outrun the unintended consequences.

Whether Mr. Greetham is right or not on the stock market, I do not know. But one thing seems pretty obvious to me. If you could lastingly improve your economy through easy money and currency debasement, Argentina would be one of the richest countries in the world today, as it indeed was at the beginning of the twentieth century, before the currency debasements of its many incompetent governments began.

No country has ever become more prosperous by debasing its currency and ripping off its savers.

This will end badly – although probably not soon.

Takeaways

What does it all mean? – I don’t know (and I could, of course, be wrong) but I guess the following:

The ECB will cut rates in June but this is the most advertised and anticipated policy easing in a long while. Euro bears will ultimately be disappointed. The ECB does not go ‘all in’, and there is no reason to do so. My hunch is that a pronounced weakening of the euro remains unlikely.

In my humble opinion, and contrary to market consensus, the ECB has run the least worst policy of all major central banks. No QE thus far; the balance sheet has even shrunk; large-scale inactivity. What is not to like?

Ms Pettifor and her fellow saver-haters will get their way in that any meaningful policy tightening is far off, including in the UK and the US. Central banks see their main role now in supporting asset markets, the economy, the banks, and the government. They are positively petrified of potentially derailing anything through tighter policy. They will structurally “under-tighten”. Higher inflation will be the endgame but when that will come is anyone’s guess. Growth will, by itself, not lead to a meaningful response from central bankers.

Abenomics will be tried but it will ultimately fail. The question is if it will first be implemented on such a scale as to cause disaster, or if it will receive its own quiet “euthanasia”, as Mr. Shirakawa seems to suggest. At Dartmouth he claimed “to have the quiet support of some Japanese business leaders who joined the Abe campaign pressuring the Shirakawa BoJ. ‘One of the surprising facts is what CEOs say privately is quite different from what they say publicly,’ he said….’in private they say, No, no, we are fed up with massive liquidity – money does not constrain our investment.’”

Economics

Statman’s tour of Britain: are average wages falling?

Incoming from Tom Paterson, chief economist at “Gold Made Simple”:

I’m currently travelling around Europe in my VW campervan with my my wife and 9 month old daughter! Well, why not!

I’ve picked up a gig at the Daily Express making short videos about the UK economy – the first one can be found here [video]:

I’ve filmed another 5 (covering the UK debt, Deficit, Govt Spending and BoE money printing)… and a new one will go live every Monday…

The Walls sausage advertisement threw me for a moment before the proper video started. Looks like a good series to watch out for.

Tom Paterson can be contacted by email here.

Economics

Whatever happened to the rate of interest?

According to the French historian Fernand Braudel, to understand the present we should master the whole of world history. The same may be said for the rate of interest: to grasp its significance we should have a full understanding of the whole of economics. Interest is the most important price of economy, the most pervading, as pointed out by the American economist Irving Fisher. Interest plays a key role in affecting all economic activity: interest and the price level are strictly interconnected, subject to leads and lags, they move in the same direction. A falling interest rate induces falling prices and a rising interest induces rising prices. Capital values are derived from income value: if interest is 5%, a capital amount yielding $100 every year has a value of $2,000. The interest rate translates, as it were, the future into the present bridging capital to its income.

When interest drops from a high down to a low level it raises the capitalized value of equipments, bonds, annuities or any other assets providing a stream of future incomes. The rate of interest reveals the individual’s rate of time preference or their “impatience for money”: the inclination towards current consumption over future consumption and vice versa. For example if the individual is indifferent between €1.04  next year and €1.00  today, his rate of time per preference per annum is four percent.

Interest can therefore be considered the minimum future amount of money required to compensate the consumer for foregoing current consumption. It is as it were, the return on sacrificing consumption towards more future consumption. When time preference falls, savings rise and interest falls. And the lower the time preference the more the supply of income saved and transferred in the form of credit to satisfy investment demand. In the economy there cannot be any real net investment without an equal amount of real net saving. The price balancing the supply of income (from savings) and the demand for it (for spending and investment) was defined by the Scandinavian economist Kurt Wicksell, the “natural rate of interest”.

Its function is to ration out existing scarce savings into productive uses and to induce to sacrifice current consumption to add to the stock of capital. The 18th century French finance minister Anne-Robert-JacquesTurgot put it this way:

The current interest of money is the is the thermometer by which the abundance or scarcity of capitals may be judged; it is the scale on which the extent of a nation’s capacity for enterprises in agriculture, manufactures, and commerce, may be reckoned.. Interest may be looked upon as a kind of like a sea level …… under which all labor, culture, industry, commerce  cease to exist». In the contemporary economy interest is a monetary tool by which central banks pretend to regulate the abundance of capital. Unfortunately in doing so they make the economy sink under the sea level. To understand this effect the rate of interest has to be investigated through its relation with money and capital.

Interest and Money

In ordinary language interest is defined either as the cost or the price for borrowing money, but these notions are partly true. If interest is a cost for the borrower is also an income for the lender. On the other hand by defining interest as a “price” we are lead into thinking that it varies inversely to the money quantity. This is what the monetary theory of the interest holds. Despite some appearance of truth it is a fallacious doctrine because being also the interest a quantity of money paid or collected against a loan it varies in direct proportion to the quantity of money. For example, if a loan was $100 earning $5, and the money supply doubled, it will rise to $200 earning $10. Interest must double to make loans equivalent (in fact: 5/100=10/200) although in percentage remains unchanged. If anything, other things being equal, an increase of money supply causes interest to rise, not to fall, for the “price of money” is not interest but money purchasing power. Furthermore the definition of interest as the price for money obscures the fact that what is exchanged in a loan is not money but present money against future money, namely credit. Credit is the temporary transfer of wealth or purchasing power from one person to another upon payment of interest. Since purchasing power is wealth and wealth producing income is capital, the rate of interest is the income paid for the use of capital. But what is used is not “abstract capital” because there is not a generic demand for capital, otherwise there would be no difference between the interest rate and the discount rate, but between the money market and the capital market. When a person asks for a loan for consumption he is not asking for capital but for money as means of payment. Who discounts bills or notes does not need capital he already has in some form or another, he wants to transform it in a more liquid form. Ultimately he needs “liquidity” not to expand his capital or business but to anticipate its monetary form. Because most businesses due to seasonal fluctuations cannot be conducted on a cash basis they need credit or liquidity just to compensate these fluctuations. The price for the temporary use of liquidity is the rate of discount. It doesn’t represent interest on capital but a rent, as it were, measuring the value of the money services namely for specific services: making the flow of the production smooth, keeping solvency or allowing specific profits in money transactions. The whole all transactions involving transfers of liquidity used to increase the marketability of all the forms of wealth  as to render them more fluid, form the money market. Here money is invested without losing its form, without turning itself into capital which is the money income employed in production. However, liquidity emerging as cash surpluses to fund cash balances deficits, is always grounded on capital operations and being limited by the use of  capital depends on the rate of interest.

Interest and capital

While the rate of discount concerns money or short term credit to anticipate the monetary form of real capital, the rate of interest concern the money or long term credit to extend real capital. So it is a long rate not a discount rate because what is lent is not money but capital (which is wealth employed in view of more future production). Hence the purpose of capital or long credit market is to provide the nexus between savers and borrowers to finance productive investments and expand the economy. Thus interest is the price balancing the supply and demand for money capital. An increased supply competing for borrowers pushes down the interest. An increases demand competing for lenders pushes up interest. The interaction supply/demand establishes the rate of interest at the point where the lenders rate of time preference tends to equal the borrowers rate of profit. This is because the use of capital depends on its marginal utility: in the market it is convenient to borrow till the income earned from the use of capital will exceed the cost of its use coinciding with the rate of time preference. So interest is the price of money capital as determined by the interaction between the least productive use and the savers’ return on sacrificing consumption. In practice it oscillates between an upper limit and a lower limit. The former is the rate of profit, otherwise borrowing would not be convenient, and the latter the rate of time preference which represents for the economy as a whole the cost of capital accumulation. This lower limit cannot be zero otherwise lenders would use income directly giving up sacrificing current consumption.

However because the rate of interest reflects the productivity of capital and it’s convenient to borrow until capital yields a positive income, it is the rate of profit that commands the rate of interest. Hence interest may also be defined as the market price of money capital typified by the rate of profit.

To the extent people are provident and have a low time preference, the capital is abundant, the rate of interest is low and long term capital-intensive projects can be undertaken, the economy expands, technological progress advances and wages productivity rises. Conversely, if the time preference is high, capital is scarce, interest higher and more liquid projects prevail. However according to the monetary theory the market rate of interest is typified by the return or yield per year on riskless long term government bonds which are deemed to typify the benchmark for the rate of profit on capital assets. Yet because governments consume instead of producing the bond yield typifies the shifts of income supply towards consumption uses. In fact the lower the bond yield the higher the government consumption and the lesser the capital available for production. Therefore bond yields reflect propensity to consume, in contrast with interests on capital reflecting propensity to invest.

Because capital it is tied up for long time in production and regain its liquid form after the sale of products, the rate of interest has a different economic nature than the rate of discount: while the latter is subject to money fluctuations, the former is less sensitive to them for it gives up its monetary form for an extended period until the time of loan repayment. Moreover by borrowing liquidity one looks at prospects of immediate gain while by borrowing capital one looks at incomes over a longer period of time. In general, the interest rate is higher than the discount rate because being less liquid commands a premium for liquidity. However when production languishes, profits fall, capital withdraws from production, interest falls while discount rate rises as demand for short-term loans rises to preserve liquidity. Interest rises during periods of economic development when present income is sacrificed and invested in capital. Once capital starts to produce new income, interest falls setting the pace for the boom period when discount rises because the higher volume of spending increases demand for money. So in general they vary independently from one another. Although there is a constellation of rates of interest depending on the loan maturities, all tend to a same level. Money capital moves where it is most needed, runs from less profitable assets to more profitable ones and like water flows to find its level. So by continuous market oscillations any capital tends to provide the same income any difference due to the risk.

It’s worth noting that if the liquidity of capital invested is lost for many years it can be regained at any time in the stock exchange by selling shares. However because shares represent titles on already existing capital, their sale does not adds to capital stock and doesn’t affect the rate of interest, rather it adds to liquidity affecting the discount rate.

Other interest rate determinants

Interest as a market price arising from the interaction between the rate of profit and the time preferences governs the price of capital assets as well as their allocation other things being equal. In fact, because the rate of profit arises in the economic system as a difference between the prices of products and the prices of factors of production to manufacture them, it is affected by these price levels. Fluctuations in these prices cause fluctuations in the rate of profit and as consequence in the rate of interest which is typified by the rate of profit. And because capital assets are determined by discounting their expected returns by interest rates of the same maturities as the life of the capital assets,it follows that all capital allocation in the market is affected by the ratio of demand to supply of both products and factors of production.

However, the value of money is also determined by supply and demand of money. If interest, in essence, depends on real factors such as time preferences, rate of profit and supply and demand, being itself a money sum must logically be dependent on the value of money although indirectly. To explain the emergence of interest the Austrian economist Eugene Bohm Bawerk argued that because present goods due to the time preference worth more than future goods of like kind and quantity, they command a premium over the future goods. In other terms, interest is the discount of future goods as against present goods or the demand price of present goods in term of future goods. However, once goods are priced in term of money, the interest rate becomes a ratio of exchange between present and future money sums and its value may not coincide with the ratio between their physical quantities because of changes occurring in the prices level. If, for example the money supply rises, the value of the expected monetary sum lent falls. Then savers expecting a rise in prices will ask for a higher interest to compensate for the loss in the value of loan capital (this confirms the mistake of monetary theory in claiming that a rise in the money supply lowers interest). Because money affects the value of real capital it’s wrong to assert (as Knut Wicksell did) that a loan might be likened to a temporary transfer of goods repayable in goods rewarded by an interest paid also in goods and determined by the supply and demand of physical goods. Interest cannot be appraised by abstracting from money because as the money value changes so does the value of real factors determining interest, all acting through money. Only if the value of money were constant would the “real” and “monetary” interest coincide.

Interest planned

As Ludwig von Mises pointed out, interest is a category of human action, a primordial phenomenon unlikely to disappear even in the most ideal world. In fact the forces determining interest prevents it from falling permanently to zero or even below. If it were zero saved income could not be exchanged for more future income or to say it differently, the valuation between present and future goods would be at par which may happen only in world where all goods would be free and no capital would be necessary to produce them. If the interest were negative future goods would command a premium on present goods, a reversal of human nature whereby present goods would be valued less than future goods and lenders would have to pay an interest instead of receiving it. The capital would shrink and the economy would regress. Such extreme values which are a little like to the absolute zero in physics, may be only inflicted to interest by exceptional circumstances such as revolutions, seizures, thefts, invasions all situations of great danger when people would prefer to pay a “penal rate” rather than lose their entire capital. Still, in the contemporary economy, similar abnormal situations are artificially created. This is because interest is not commanded by the self generating forces regulating the rate of interest, but by the central banks planned monetary policy closely related to the governments’ fiscal policy.

Central banks set an official or discount rate, a minimum and arbitrary lending rate, the “price for liquidity”, which varies through monetary policy consisting of buying and selling in the open market governments issued bonds against such liquidity. Thus monetary policy acts as a pressure and suction pump alternately decreasing and increasing the quantity of money to push the interest up and down either to keep bonds in the desired relationship with the official rate or to provide a money supply favorable to economic stability and growth. In so doing central banks mimic the natural tendency of interest. For example by expanding money supply during recessions they lower the official rate as this were the after effect of new income streams arising out of foregoing savings required to restore economic growth. The long term rate then changes through expectations towards the official rate: if the latter falls the former is expected to rise and vice versa. However because interests are used to determine the present value of capital assets by discounting their expected income, monetary policy misprices capital assets and misallocate them. This is because the entire interest market structure (the relationship among interest rates influencing prices of income producing assets of different maturity) depends solely on liquidity fluctuations commanded by monetary policy which is completely divorced from the real factors that determine the interest and lay the foundation of liquidity. So not in any sense can the market rate of interest be compared with the one determined by central banks. By ignoring the distinction between money and capital, monetary policy denies the natural function of time preferences and rate of profit confining them to an adaptive role vis-à-vis of their monetary manipulation.

On the other hand because government bonds provide the basis for the money expansion that grows as interest drops, the official rate may be looked upon as a tool of fiscal policy reflecting capital dissipation.This is because central banks pay for these bonds not with income released by foregoing capital operations, but with means of payment they themselves “coin” and lend as they were saved income. This manoeuvre – also known as credit easing – is tantamount to discounting and putting into circulation expected wealth as if it were current wealth, to consume or to use as capital. In other words, central banks by advancing means of payment act as the future were so prosperous as to pledge an ever increasing wealth allowing for their repayment. But the fact is that the most of these means of payment passed off as an existent wealth besides using up, without replacing, the wealth already produced, will never be repaid for they will be misallocated into unproductive uses by a rate of interest not reflecting the existence of money capital but the mere expansion of means of payment that, as already pointed out, should cause interest to rise, not to fall. The paradox is that subsequent rounds of this expansion entail equivalent rounds of waste making capital scarcer and scarcer. Thus economic downturns are just the result of the attempt to create capital on the foundation of monetary policy rather than on the foundation of the real factors determining the rate of interest. Unfortunately, they tend to become permanent to the extent central banks in trying to alleviate them expand money by buying bonds on a huge scale so as to push interest down to zero. But at this level lenders, having no incentive to turn income into capital, will turn capital into income which means they will be living out of their capital until is depleted. As interest vanishes “under the sea level” so does capital till “labour, culture, industry, or commerce will cease to exist” as Turgot predicted long ago.

Economics

Madness!

“Central bankers control the price of money and therefore indirectly influence every market in the world. Given this immense power, the ideal central banker would be humble, cautious and deferential to market signals. Instead, modern central bankers are both bold and arrogant in their efforts to bend markets to their will. Top-down central planning, dictating resource allocation and industrial output based on supposedly superior knowledge of needs and wants, is an impulse that has infected political players throughout history. It is both ironic and tragic that Western central banks have embraced central planning with gusto in the early twenty-first century, not long after the Soviet Union and Communist China abandoned it in the late twentieth. The Soviet Union and Communist China engaged in extreme central planning over the world’s two largest countries and one-third of the world’s population for more than one hundred years combined. The result was a conspicuous and dismal failure. Today’s central planners, especially the Federal Reserve, will encounter the same failure in time. The open issues are, when and at what cost to society ?”

- James Rickards, ‘The death of money: the coming collapse of the international monetary system’, 2014. [Book review here]

“Sir, On the face of it stating that increasing the inheritance tax allowance to £1m would abolish the tax for “all except a very small number of very rich families” (April 5) sounds a very reasonable statement for the Institute for Fiscal Studies to make, but is £1m nowadays really what it used to be, bearing in mind that £10,000 was its equivalent 100 years ago ?

“A hypothetical “very rich” person today could have, for example, a house worth £600,000 and investments of £400,000. If living in London or the South East, the house would be relatively modest and the income from the investments, assuming a generous 4 per cent return, would give a gross income of £16,000 a year, significantly less than the average national wage.

“So whence comes the idea that nowadays such relatively modest wealth should be classified as making you “very rich” ? The middle-aged should perhaps wake up to the fact that our currency has been systematically debased, though it may be considered impolite to say so as it challenges the conventional political and economic wisdom. To be very rich today surely should mean you have assets that give you an income significantly higher than the national average wage ?”

- Letter to the editor of the Financial Times from Mr John Read, London NW11, 12 April 2014

“The former coach house in Camberwell, which has housed the local mayor’s car, was put on the market by Southwark council as a “redevelopment opportunity”. At nearly £1,000 per square foot, its sale value is comparable to that of some expensive London homes.”

- ‘London garage sells for £550,000’ by Kate Allen, The Financial Times, 12 April 2014.

“Just Eat, online takeaway service, slumped below its float price for the first time on Tuesday as investors dumped shares in a raft of recently floated web-based companies amid mounting concern about their high valuations..

“Just Eat stunned commentators last week when it achieved an eye-watering valuation of £1.47 billion, more than 100 times its underlying earnings of £14.1 million..

““They have fallen because the company was overvalued. Just Eat was priced at a premium to Dominos, an established franchise that delivers and makes the pizzas and has revenues of £269 million. Just Eat by comparison is a yellow pages for local takeaways where there is no quality control and no intellectual property and made significantly less revenues of £96.8 million. A quality restaurant does not need to pay 10 per cent commission to Just Eat to drive customers through the door,” Michael Hewson, chief market analyst at CMC Markets said.”

- ‘Investors lose taste for Just Eat as tech stocks slide’ by Ashley Armstrong and Ben Martin,

The Daily Telegraph, 8 April 2014.

Keep interest rates at zero, whilst printing trillions of dollars, pounds and yen out of thin air, and you can make investors do some pretty extraordinary things. Like buying shares in Just Eat, for example. But arguably more egregious was last week’s launch of a €3 billion five-year Eurobond for Greece, at a yield of just 4.95%. UK “investors” accounted for 47% of the deal, Greek domestic “investors” just 7%. Just in case anybody hasn’t been keeping up with current events, Greece, which is rated Caa3 by Moody’s, defaulted two years ago. In the words of the credit managers at Stratton Street Capital,

“The only way for private investors to justify continuing to throw money at Greece is if you believe that the €222 billion the EU has lent to Greece is entirely fictional, and will effectively be converted to 0% perpetual debt, or will be written off, or Greece will default on official debt while leaving private creditors untouched.”

In a characteristically hubris-rich article last week (‘Only the ignorant live in fear of hyperinflation’), Martin Wolf issued one of his tiresomely regular defences of quantitative easing and arguing for the direct state control of money. One respondent on the FT website made the following comments:

“The headline should read, ‘Only the EXPERIENCED fear hyperinflation’. Unlike Martin Wolf’s theorising, the Germans – and others – know only too well from first-hand experience exactly what hyperinflation is and how it can be triggered by a combination of unforeseen circumstances. The reality, not a hypothesis, almost destroyed Germany. The Bank of England and clever economists can say what they like from their ivory towers, but meanwhile down here in the real world, as anyone who has to live on a budget can tell you, every visit to the supermarket is more expensive than it was even a few weeks ago, gas and electricity prices have risen, transport costs have risen, rents have risen while at the same time incomes remain static and the little amounts put aside for a rainy day in the bank are losing value daily. Purchasing power is demonstrably being eroded and yet clever – well paid – people would have us believe that there is no inflation to speak of. It was following theories and forgetting reality that got us into this appalling financial mess in the first place. Somewhere, no doubt, there’s even an excel spreadsheet and a powerpoint presentation with umpteen graphs by economists proving how markets regulate themselves which was very convincing up to the point where the markets departed from the theory and reality took over. I’d rather trust the Germans with their firm grip on reality any day.”

As for what “inflation” means, the question hinges on semantics. As James Turk and John Rubino point out in the context of official US data, the inflation rate is massaged through hedonic quality modelling, substitution, geometric weighting and something called the Homeowners’ equivalent rent. “If new cars have airbags and new computers are faster, statisticians shave a bit from their actual prices to reflect the perception that they offer more for the money than previous versions.. If [the price of ] steak is rising, government statisticians replace it with chicken, on the assumption that this is how consumers operate in the real world.. rising price components are given less relative weight.. homeowners’ equivalent rent replaces what it actually costs to buy a house with an estimate of what homeowners would have to pay to rent their homes – adjusted hedonically for quality improvements.” In short, the official inflation rate – in the US, and elsewhere – can be manipulated to look like whatever the authorities want it to seem.

But people are not so easily fooled. Another angry respondent to Martin Wolf’s article cited the “young buck” earning £30K who wanted to buy a house in Barnet last year. Having saved for 12 months to amass a deposit for a studio flat priced at £140K, he goes into the estate agency and finds that the type of flat he wanted now costs £182K – a 30% price increase in a year. Now he needs to save for another 9 years, just to make up for last year’s gain in property prices.

So inflation is quiescent, other than in the prices of houses, shares, bonds, food, energy and a variety of other financial assets.

The business of rational investment and capital preservation becomes unimaginably difficult when central banks overextend their reach in financial markets and become captive to those same animal spirits. Just as economies and markets are playing a gigantic tug of war between the forces of debt deflation and monetary inflation, they are being pulled in opposite directions as they try desperately to anticipate whether and when central bank monetary stimulus will subside, stop or increase. Central bank ‘forward guidance’ has made the outlook less clear, not more. Doug Noland cites a recent paper by former IMF economist and Reserve Bank of India Governor Raghuram Rajan titled ‘Competitive Monetary Easing: Is It Yesterday Once More ?’ The paper addresses the threat of what looks disturbingly like a modern retread of the trade tariffs and import wars that worsened the 1930s Great Depression – only this time round, as exercised by competitive currency devaluations by the larger trading economies.

Conclusion: The current non-system [a polite term for non-consensual, non-cooperative chaos] in international monetary policy [competitive currency devaluation] is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector. It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action. We are being pushed towards competitive monetary easing. If I use terminology reminiscent of the Depression era non-system, it is because I fear that in a world with weak aggregate demand, we may be engaged in a futile competition for a greater share of it. In the process, unlike Depression- era policies, we are also creating financial sector and cross-border risks that exhibit themselves when unconventional policies come to an end. There is no use saying that everyone should have anticipated the consequences. As the former BIS General Manager Andrew Crockett put it, ‘financial intermediaries are better at assessing relative risks at a point in time, than projecting the evolution of risk over the financial cycle.’ A first step to prescribing the right medicine is to recognize the cause of the sickness. Extreme monetary easing, in my view, is more cause than medicine. The sooner we recognize that, the more sustainable world growth we will have.

The Fed repeats its 2% inflation target mantra as if it were some kind of holy writ. 2% is an entirely arbitrary figure, subject to state distortion in any event, that merely allows the US government to live beyond its means for a little longer and meanwhile to depreciate the currency and the debt load in real terms. The same problem in essence holds for the UK, the euro zone and Japan. Savers are being boiled alive in the liquid hubris of neo-Keynesian economists explicitly in the service of the State.

Doug Noland again:

“While I don’t expect market volatility is going away anytime soon, I do see an unfolding backdrop conducive to one tough bear market. Everyone got silly bullish in the face of very serious domestic and global issues. Global securities markets are a problematic “crowded trade.” Marc Faber commented that a 2014 crash could be even worse than 1987. To be sure, today’s incredible backdrop with Trillions upon Trillions of hedge funds, ETFs, derivatives and the like make 1987 portfolio insurance look like itsy bitsy little peanuts. So there are at this point rather conspicuous reasons why Financial Stability has always been and must remain a central bank’s number one priority. Just how in the devil was this ever lost on contemporary central bankers?”