I wrote what I thought was a fairly simple article for Forbes on Tuesday. I noticed that some people really got it, and they were very excited. However, others were skeptical or asking questions that went into the weeds. The former tells me that I said something important, but the latter says that I said it in a way that not everyone could relate to.
I started with the observation that many people argue (vehemently) that money should be defined as the medium of exchange. In the US, the dollar is used to purchase everything. Therefore the dollar circulates as the medium of exchange. Therefore the dollar is money. Q.E.D.
The catch is that the dollar only circulates because the government forces it to circulate, and forces gold not to. This means that the very concept of money is under the control of the government.
Ayn Rand noted that force is not essentially about a physical push, or a bullet hitting flesh. She said, “Force and mind are opposites…” She added, “To force a man to drop his own mind and to accept your will as a substitute, with a gun in place of a syllogism, with terror in place of proof, and death as the final argument—is to attempt to exist in defiance of reality.”
She showed that force is an attack on the mind. Literally, the gun takes away your ability to see reality clearly and use logic to arrive at the best possible outcome. Instead, you must think and do as you are told. The insidious process she described is at work with the concept of money. The very concept of money has been perverted.
In most cases, people can see that government has no power to change reality, or alter the laws of physics. But in this case—by the leverage of a broken concept—many people assume that government has indeed the power to make concepts into what it wishes.
George Orwell once wrote about this.
Debt paper is not money, no matter who issues it. The government has no power to transform water into wine, or debt paper into money. I don’t think anyone is explicitly arguing that it has this power. I think their error is to gloss over why the dollar circulates, and just insist that, “well, it circulates therefore it is money.”
Thus, the government is granted the power to turn paper into gold, though the mind skitters away from openly admitting this conclusion.
The consequence to accepting the dollar as money is to think that gold goes up. As I often say, in reality, gold is going nowhere. It’s the dollar that is going down. But if the dollar is money, then the prices of all things are measured in dollars. And so, we think gold goes up. Because that’s the only way to frame it if the dollar is money.
If gold goes up, then one has made a profit. That’s right, one makes money for doing nothing, just holding a lump of metal. Where does such a free lunch come from? No time to explore that contradiction today. Let’s stay focused.
It may not be fair, but we have a capital gains tax that applies when an investment, commodity, or asset goes up. If you buy something for $1,000 and sell it for $1,500, then you have a $500 profit. You must pay tax on that income. There are no exceptions that I am aware of: antique Ferraris, stocks, bonds, bitcoin, copper, houses, etc.
And this is where the concept of money gets real.
The government has several ways of forcing gold not to circulate, of making us use their debt paper as if it were money. One of them is the capital gains tax on gold. You see, if you barter—remember, gold is not money, just a commodity—gold for a car then the government considers that to be a sale of gold at the current market price. If that is higher than what you paid when you bought, then you owe capital gains tax.
This tax makes it far too expensive to use gold in transactions, not to mention the ledger you would have to keep. So gold is forced out of circulation (and into private hoards). Gold is for holding, not for using as money.
I have been arguing that this bad tax provision ought to be repealed. And that’s the crux of the problem.
Am I just a crony, like every other crony, asking the government for a special favor and preferential treatment? Is the whole point of repealing the tax on gold so that gold speculators can make more money on their gold trades?
This was essentially the allegation of one Arizona legislator, who asked why gold should be treated differently than other investments.
If the dollar is money, then there is no good answer to this question.
To advocate for special privileges that benefit one’s own purse is to fight for cronyism (also known by its older name, fascism). This is not a principled position. Nor is it a sympathetic one. Everyone has a mental picture of a fat cats, seeking to engorge himself as public expense. Once we’re into that box, once we’re perceived that way, we’re doomed. No matter what “blah blah blah” comes out of our mouths, it will be seen as self-serving and hypocritical. And rightfully so.
Huh? Rightfully so?!? Yes. If we concede that the dollar is money, gold is a commodity, and if we concede that gold is going up, which means we make a profit, and if we demand not to be taxed on that profit, then we are no different than any other special interest group seeking favoritism. We are no different than any other rent seekers.
What is a principled free marketer to do? Well, if you cling to the notion that the dollar is money, then you are disarmed. You have to concede that gold should be taxed just like other assets. You can lobby to eliminate all capital gains tax, but that’s about it. Good luck with that. I will cheer you, but don’t expect victory any time soon.
I remind you of two things. One, tax keeps gold from circulating. In other words, the gold tax is the key to socialized money. We can never have a free market in money if gold is penalized with a tax every time the dollar loses value. Two, as Ayn Rand showed, the moral is the practical. Your belief in this bad definition of money is what keeps you from effectively fighting for a free market in money.
There is much more to say about the topic of money and credit, to support the case that gold is money. In this article, I just wanted to focus on this one issue, because I think the error is an important one. I expect gold’s enemies, as they begin to mobilize and organize, will be cunning enough to see the vulnerability and go for the jugular.
If we want to win, we will need to be armed properly for the fight. This is a battle for ideas, and the most important weapons we can wield are concepts. Preferably razor sharp concepts. Let’s get it right, starting with a clear understanding of the dollar and of gold.
The European Central Bank has announced its intention to create out of thin air over one trillion new Euros from March 2015 to September 2016. The rationale, the monetary central planners say, is to prevent price deflation and “stimulate” the European economy into prosperity.
The only problem with their plan is that their concern about “deflation” is a misguided fear, and printing money can never serve as a long-term solution to bring about sustainable economic growth and prosperity.
Europe’s High Unemployment and Economic Stagnation
The European Union (of which the Euro currency zone is a subset) is experiencing staggering levels of unemployment. The EU as a whole has 10 percent of the work force unemployed, and 11.5 percent in the Euro Zone.
But breaking these numbers down to the national levels show just how bad the unemployment levels are in the different member countries. In Greece it is nearly 26 percent of the work force. In Spain, it is 24 percent; Italy and Portugal are both over 13 percent. France has over 10 percent unemployment, with Sweden at 8 percent. Only Germany and Austria have unemployment of 5 percent or less out of the 28-member countries of the European Union.
Youth unemployment (defined as those between 16 and 25 years of age unable to find desired work) is even more catastrophic. For the European Union as a whole it is an average of over 22 percent, and more than 23 percent in the Euro Zone.
In Greece, its almost 60 percent of those under 25; in Spain, it is nearly 55 percent, with Italy at 43 percent, and over 22 percent in both France and Sweden. Only in Norway and Germany is youth unemployment less than 8 percent. Almost all the other EU countries are in the double-digit range.
At the same time, growth in Gross Domestic Product for the European Union as a whole in 2014 was well below one percent. Only in the Czech Republic, Norway, and Poland was it above 2 percent among the EU members.
Consumer prices for the EU averaged 0.4 percent in 2014, with most of the member countries experiencing average consumer price increases between 0.2 and 2 percent for the year. Only in Greece was the average level of prices calculated as having absolutely declined by a minus 1.3 percent. Hardly a measured sign of dramatically suffered price deflation in the EU or the Euro Zone!
Fears of Price Deflation are Misplaced
The monetary central planners who manage the European Central Bank are fearful that the Euro Zone may be plagued by a prolonged period of generally falling prices if they do not act to push measured price inflation towards their desired target of around two percent a year.
(It is worth pointing out that if the Euro Zone monetary central planners were to succeed with their goal and maintain two percent average annual price inflation, this would mean that over a twenty-year period the purchasing power of a Euro would decline by around 50 percent.)
Many commentators inside and outside of the European Union and the Euro Zone have insisted that price deflation needs to be prevented or reversed at all costs. The implicit premise behind their arguments is that deflation equals economic depression or recession, and therefore any such decline in prices in general must not be allowed.
In all these discussions it is often ignored or forgotten that annual falling prices can well be an indication of economic prosperity and rising standards of living. For instance, between 1865 and 1900, prices in general in the United States declined by around 50 percent, with overall standards of living in general estimated to have increased by 100 percent over these 35 years. This period is usually recognized as America’s time of rapid industrialization in the post-Civil War era that set the United States on the path to becoming the world’s economic giant through most of the 20thcentury.
Falling Prices and Improved Standards of Living
A hallmark of an innovative and competitive free market economy is precisely the never-ending attempt by entrepreneurs and enterprisers to devise ways to make new, better and less expensive goods to sell to the consuming public. The stereotypes in modern times have been pocket calculators, mobile phones, DVD players, and flat-screen TVs.
When pocket calculators first came on the market in the 1980s, they were too big to fit in your shirt pocket, basically performed only the most elementary arithmetic functions, and cost hundreds of dollars. Within a few years they fit in your shirt pocket with space to spare, performed increasingly complex mathematical functions, and became so inexpensive that many companies would give them away as advertising gimmicks.
The companies that made them did not proclaim their distress due to the lower and lower prices at which they sold the devices. Cost efficiencies were developed and introduced in their manufacture so they could be sold for less to consumers to expand demand and capture a larger share of a growing market.
In a dynamic, innovative and growing free market economy there normally would be a tendency for one product after another being improved in its quality and offered at lower prices as productivity gains and decreased costs made them less expensive to market and still make a profit.
Looking over a period of time, a statistical averaging of prices in general in the economy would no doubt show a falling price level, or “price deflation,” as one price after another experienced such a decline. This would be an indication of rising standards of living as the real cost of buying desired goods with our money incomes was decreasing.
Europe’s Problems are Due to Anti-Market Burdens
Relatively stagnant economies with high rates of unemployment like in the European Union and the Euro Zone are not signs of deflationary forces preventing growth and job creation. Indeed, since 2008, the European Central Bank has increased its balance sheet through monetary expansion by well over one trillion Euros, and prices in the Euro Zone, in general, have been rising on average between 0.5 and 2 percent throughout this period. Hardly an indication of “deflationary” forces at work.
The European Union’s problems are not caused by a lack of “aggregate demand” in the form of money spending. Its problems are on the “supply-side.” The EU is notorious for rigid labor markets in which trade unions limit worker flexibility and workplace adaptiveness to global market change.
Above market-determined wages and benefits price many who could be gainfully employed out of a possible job, because government policies and union power price these potential employees out of the market. Plus, the difficulty of firing someone once a worker is hired undermines the incentives of European companies to want to expand their work forces.
Even a number of international organizations, usually culprits in fostering anti-free market policies, have pointed out the need for European governments to introduce workplace reforms to free up labor markets in their countries, along with general reductions in regulations on business than hamper entrepreneurial incentives and prevent greater profit-oriented competitiveness.
Creating a Trillion Euros will only Imbalance Europe More
Creating a trillion more Euros cannot overcome or get around anti-competitive regulations, cost-price mismatches and imbalances due to government interventions and union restrictions, or the burdensomeness of taxes that reduce the willingness and ability of businessmen to undertake the enterprising activities that could lift Europe out of its economic malaise.
Furthermore, to the extent to which the European Central Bank succeeds in injecting this trillion Euros into the European economy it will only set in motion the danger of another future economic downturn. Not only may it feed an unsustainable financial and stock market run-up. The very manner in which the new money is introduced into the European-wide economy will inevitably distort the structure of relative prices and wages; wrongly twist the patterns of resource and labor uses; and induce forms of mal-invested capital.
Thus, the attempt to overcome Europe’s stagnant economy through monetary expansion will be the cause of a misdirection of labor, capital and production that will inescapably require readjustments and rebalances of supplies and demands, and price relationships that will mean people living through another recession at some point in the future.
A Market-Based Agenda for Growth and Jobs
What, then might be a “positive” pro-market agenda for economic recovery and job creation in the European Union, and in the United States, as well, for that matter? Among such policies should be:
- Significantly reduce marginal personal tax rates and corporate taxes, and eliminate inheritance taxes; this would create greater incentives and the financial means for private investment, capital formation and job creation;
- Cut government spending across the board by at a minimum of 10 percent more than taxes have been cut so to move the government in the direction of a balanced budget without any tax increases; this would take pressure off financial markets to fund government deficits, and end the growth in accumulated government debt, until finally government budgets would have surpluses to start paying down that debt;
- Reduce and repeal government regulations over the business sector and financial institutions to allow competitive forces to operate and bring about necessary adjustments and corrections for restoring economic balance;
- Institute real free trade through elimination and radical reduction of remaining financial and regulatory barriers to the competitive free flow of goods among countries;
- End central bank monetary expansions and manipulation of interest rates; interest rates need to tell the truth about savings availability and investment profitability for long-run growth that is market-based and sustainable. Monetary expansion merely sends out false signals that distort the normal functioning of the market economy.
A market-based set of policies such as these would serve as the foundation for a sound and sustainable real “stimulus” for the European and American economies. It also would be consistent with the limited government and free enterprise principles at the foundation of a free society.
The European Central Bank (ECB) is planning to pump 1.1 trillion euro’s into the banking system to fend off price deflation and revive economic activity. The ECB president and his executive board are planning to spend 60 billion euro’s a month from March 2015 to September 2016.
Most experts hold that the ECB must start acting aggressively against the danger of deflation. The yearly rate of growth of the consumer price index (CPI) fell to minus 0.2% in December last year from 0.3% in November and 0.8% in December 2013.
Many commentators are of the view that the ECB should initiate an aggressive phase of monetary pumping along the lines of the US central bank. Moreover the balance sheet of the ECB has in fact been shrinking. On this the yearly rate of growth of the ECB balance sheet stood at minus 2.1% in January against minus 8.5% in December. Note that in January last year the yearly rate of growth stood at minus 24.4%.
Why is a declining rate of inflation bad for economic growth? According to the popular way of thinking declining price inflation sets in motion declining inflation expectations. This, so it is held, is likely to cause consumers to postpone their buying at present and that in turn is likely to undermine the pace of economic growth.
In order to maintain their lives and well being individuals must buy present goods and services, so from this perspective a fall in prices as such is not going to curtail consumer outlays. Furthermore, a fall in the growth momentum of prices is always good for the economy.
An expansion of real wealth for a given stock of money is going to manifest in a decline in prices (remember a price is the amount of money per unit of real stuff), so why should this be regarded as bad for the economy?
After all, what we have here is an expansion of real wealth. A fall in prices implies a rise in the purchasing power of money, and this in turn means that many more individuals can now benefit from the expansion in real wealth.
Now, if we observe a decline in prices on account of an economic bust, which eliminates various non-productive bubble activities, why is this bad for the economy?
The liquidation of non-productive bubble activities – which is associated with a decline in the growth momentum of prices of various goods previously supported by non-productive activities – is good news for wealth generation.
The liquidation of bubble activities implies that less real wealth is going to be diverted from wealth generators. Consequently, this will enable them to lift the pace of wealth generation. (With more wealth at their disposal they will be able to generate more wealth).
So as one can see a fall in price momentum is always good news for the economy since it reflects an expansion or a potential expansion in real wealth.
Hence a policy aimed at reversing a fall in the growth momentum of prices is going to undermine and not strengthen economic growth.
We hold that the various government measures of economic activity reflect monetary pumping and have nothing to do with true economic growth.
An increase in monetary pumping may set in motion a stronger pace of growth in an economic measure such as gross domestic product. This stronger growth however, should be regarded as a strengthening in the pace of economic impoverishment.
It is not possible to produce genuine economic growth by means of monetary pumping and an artificial lowering of interest rates. If this could have been done by now world poverty would have been erased.
Summary and conclusion
The European Central Bank (ECB) is planning to pump 1.1 trillion euro’s into the banking system to fend off price deflation and revive economic activity in the Euro-zone. Most experts are supportive of the ECB’s plan. We question the whole logic of the monetary pumping.
A fall in the growth momentum of prices either on account of real wealth expansion or on account of the demise of bubble activities is always good news for wealth producers.
Hence any policy that is aimed at preventing a fall in prices is only likely to strengthen bubble activities and undermine the process of wealth generation.
Washington finally shows signs of coming to grips with the importance of money to politics. This is not about mere campaign finance. Recently there was a breakthrough in bringing the money policy issue out of the shadows and to center stage … where it belongs.
The real issue of money in politics is about the Fed, not the Kochs. The Fed’s political impact is orders of magnitude greater than all the billionaires’ money, bright and dark, left and right, combined.
There was a real breakthrough in the discourse last week. This breakthrough deserves far more attention than it yet has received.
The Washington Post’s Matt O’Brien, one of the smartest cats in the (admittedly small and dark, but crucial) monetary policy alley, published a column at the Post’s Wonkblog entitled Yes the Federal Reserve has enormous power over who is president.
The arc of the political universe is long, but it bends towards monetary policy.
That’s the boring truth that nobody wants to hear. Forget about the gaffes, the horserace, and even the personalities. Elections are about the economy, stupid, and the economy is mostly controlled by monetary policy. That’s why every big ideological turning point—1896, 1920, 1932, 1980, and maybe 2008—has come after a big monetary shock.
Think about it this way: Bad monetary policy means a bad economy, which gives power back to the party that didn’t have it before. And so long as the monetary problem gets fixed, the economy will too, and the new government’s policies will, whatever their merits, get the credit. That’s how ideology changes.
O’Brien’s column may, just possibly, represent a watershed turn in the political conversation. Game on.
O’Brien demolishes not one but two myths. The first myth is of the Fed as politically independent. The second is that monetary policy properly resides outside the electoral process.
As I wrote here in a column Dear Chair Yellen: Mend the Fed:
As journalist Steven Solomon wrote in his indispensable exploration of the Fed, The Confidence Game: How Unelected Central Bankers Are Governing the Changed World Economy (Simon & Schuster, 1995):
Although they strained to portray themselves as nonthreatening, nonpartisan technician-managers of the status quo, central bankers, like proverbial Supreme Court justices reading election returns, used their acute political antennae to intuit how far they could lean against the popular democratic winds. “Chairmen of the Federal Reserve,” observes ex-Citibank Chairman Walter Wriston, “have traditionally been the best politicians in Washington. The Fed serves a wonderful function. They get beat up on by the Congress and the administration. Everyone knows the game and everyone plays it. But no one wants their responsibility.”
Moreover, as to the political delicacy of this position, I wrote:
To consistently be in what iconic Fed Chairman William McChesney Martin called “the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up” is just asking too much of most mere mortals. It asks too much even of officials of such admirable integrity, intellect, and heart as Janet Yellen (and Chair Yellen’s deeply admirable Vice Chair Stanley Fischer, most recently seen talking with protestors at Jackson Hole).
Monetary policy has been relegated to the Fed and largely excluded from the formal electoral process for almost two generations. This is, at it happens, and as O’Brien states forthrightly, a historical anomaly.
Monetary policy was a white hot topic at the Constitutional Convention of 1787. Thereafter, it was crucial to the success of George Washington’s administration, one of the few matters in which cabinet members Thomas Jefferson and Alexander Hamilton concurred.
Monetary policy — in the North, “Greenbacks” — was a huge (and later litigated) issue during and after the Civil War.
Monetary policy was a fundamental issue for Grover Cleveland.
Monetary policy was the issue that propelled the young William Jennings Bryan to national prominence and three presidential nominations, beginning with his famous “cross of gold” speech.
Monetary policy was a, perhaps the, prime issue on which William McKinley campaigned (and won).
After the Panic of 1907 monetary policy was a central issue for U.S. Senator Nelson Aldrich, then called America’s “General Manager.” Aldrich chaired the National Monetary Commission. He wittily noted, in a 1909 speech, that “[T]he study of monetary questions is one of the leading causes of insanity.”
Thereafter — with the creation of the Fed — monetary policy became a key issue for Woodrow Wilson. As recorded in Historical Beginnings. The Federal Reserve by Roger T. Johnson, (published by The Federal Reserve Bank of Boston, revised 2010)
On December 23, just a few hours after the Senate had completed action, President Wilson, surrounded by members of his family, his cabinet officers, and the Democratic leaders of Congress, signed the Federal Reserve Act. “I cannot say with what deep emotions of gratitude… I feel,” the President said, “that I have had a part in completing a work which I think will be of lasting benefit to the business of the country.”
FDR’s revaluing gold, on the advice of agricultural economist George Warren, was crucial to lifting the Depression. This was a matter so politically dramatic as to land Warren on the cover of Time Magazine.
The importance of FDR’s action cannot be minimized. As I have elsewhere written:
As (conservative economic savant Jacques) Rueff observed in The Monetary Sins of the West (The Macmillan Company, New York, New York, 1972, p. 101):
“Let us not forget either the tremendous disaster of the Great Depression, carrying in its wake countless sufferings and wide-spread ruin, a catastrophe that was brought under control only in 1934, when President Roosevelt, after a complex mix of remedies had proved unavailing, raised the price of gold from $20 to $35 an ounce.”
As investment manager Liaquat Ahamed wrote in his Pulitzer Prize winning history Lords of Finance: The Bankers Who Broke the World (The Penguin Press, New York, 2009, pp. 462-463):
“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.”
Of course, FDR did not take the dollar off gold. He revalued. That FDR did not have a firm grasp on the implications of his own policy is evidenced by his Treasury’s sterilization of gold inflows, arguably a leading factor leading to the 1937 double dip back into Depression.
Monetary policy figured more than tangentially in President Nixon’s “New Economic Policy,” announced in a national address on August 15, 1971. The inflationary consequences of Nixon’s closing of the gold window — and the easy money policy he bullied out of the Fed — figured prominently in the Ford and Carter administrations. The symptom of bad monetary policy — runaway inflation — was a major contributing factor in the election of Ronald Reagan.
A period that has been called the Great Moderation — under Fed Chairman Paul Volcker and the first two terms of Chairman Greenspan — followed. This saw the creation of almost 40 million new jobs, and economic mobility. This tookmonetary policy largely off the political agenda for almost two generations.
Then, of course, came the unexpected financial meltdown of 2008. That event — and the ensuing soggy recovery — helped propel monetary policy back into the realm of electoral politics.
The Republican Party national platform of 2012 called for the establishment of a monetary “commission to investigate possible ways to set a fixed value for the dollar.” This is something for which American Principles in Action (which I professionally advise) was and is a leading advocate.
This plank, widely noted around the world, directly led to the introduction, by Joint Economic Committee chairman Kevin Brady (R-Tx), of Centennial Monetary Commission legislation, which attracted 40 House and two Senate co-sponsors. It is expected to be reintroduced early in the 114th Congress.
The monetary commission legislation meticulously is bipartisan in nature. It includes ex-officio commissioners to be appointed by the Fed Chair and Treasury Secretary. It has been widely, and universally, praised in the financial press … including the FT, the Wall Street Journal, and Forbes.com. It is purely empirical in intent and has attracted the public support of many important civic leaders in the policy and political arena.
Last winter the commission received a unanimous resolution of support from the Republican National Committee. Democrats and progressives, of the kind of progressive Democrat President Cleveland, also well can support it.
There are a number of things about which one might quibble in O’Brien’s column. (O’Brien, for instance, reflexively opposes the gold standard. Yet the facts and analysis on which he rests his objections are incomplete.)
That said, O’Brien gets the big thing right: “The arc of the political universe is long, but it bends towards monetary policy.” Such an important columnist for the Post getting the big thing right is in and of itself a Big Thing.
Good money — and how to make our money good — is a matter that belongs at the center of our national, and, especially, presidential, politics. Good money is central to restoring job creation, economic mobility, equitable prosperity, the integrity of our savings and the solvency of our banks.
We are in what trenchantly has been called “uncharted territory.” Among issues which deserve a “national conversation” good money deserves the place at the head of the line. Fed Chair Yellen has been described, astutely, by Politico as having the Toughest job in Washington. It is high time for our elected officials — and presidential aspirants — to shoulder more responsibility. It is high time for monetary policy, after being in political near-hibernation for almost two generations, to enter the 2016 presidential debate.
Originating at Forbes.com: http://www.forbes.com/sites/ralphbenko/2015/01/19/monetary-politics-the-biggest-money-player-in-politics-is-the-fed/
2014 ended with two ominous developments: the strength of the US dollar and a collapse in key commodity prices.
It is tempting to view both events as one, but the continuing fall in oil prices through December reveals they are sequential: first there was a greater preference for dollars compared with other currencies and this still persists, followed by a developing preference for all but the weakest currencies at the expense of raw materials and energy. These are two steps on a path that should logically lead to a global slump.
Dollar strength was the first warning that things were amiss, leading to higher interest rates in many of the emerging economies as their central banks sought to control investment outflows. Since this followed a prolonged period of credit expansion these countries appear to be entering the bust phase of the credit-driven boom-and-bust cycle; so for them, 2015 at a minimum will see a slump in economic activity as the accumulated malinvestments from the past are unwound. According to the IMF database, emerging market and developing economies at current prices account for total GDP of over $30 trillion, compared with advanced economies’ GDP totalling $47 trillion. It is clear that a slump in the former will have serious repercussions for the latter.
As the reserve currency the dollar is central to the exchange value of all other currencies. This is despite attempts by China and Russia to trade without it. Furthermore and because of this dependency, the global economy has become more geared to the dollar over the years because it has expanded relative to the US. In 2000, the US was one-third of global GDP; today it is about one-fifth.
The second development, falling energy and commodity prices, while initially driven by the same factors as dollar strength, confirms the growing likelihood of a global slump. If falling prices were entirely due to increased supply of the commodities involved, we could rejoice. However, while there has been some increase in energy and commodity supply the message is clear, and that is demand at current prices has unexpectedly declined, and prices are now trying to find a new equilibrium. And because we are considering world demand, this development is being missed or misread by economists who lack a global perspective.
The price of oil has approximately halved in the last six months. The fall has been attributed variously to the west trying to bankrupt Russia, or to Saudi Arabia driving American shale production out of business. This misses the bigger picture: according to BP’s Statistical Review 2014, at the beginning of last year world oil consumption comfortably exceeded supply, 91.3million barrels per day compared with 86.8. This indicates that something fundamental changed in 2014 to collapse the price, and that something can only be a sudden fall in demand in the second half.
Iron ore prices have also halved over the last six months, but other key commodities, such as copper which fell by only 11% over the period, appear to have not yet adjusted to the emerging markets slump. This complies with business cycle theory, because in the early stages of a slump businesses remain committed to their capital investment plans in the vain hope that conditions will improve. This being the case, the collapse in demand for energy can be expected to deepen and spread to other industrial raw materials as manufacturers throw in the towel and their investment plans are finally abandoned.
Therefore the economic background to the financial outlook for the global economy is not encouraging. Nor was it at the beginning of 2014, when it was obviously going to be a difficult year. The difference a year on is that the concerns about the future are more crystallised. This time last year I wrote that we were heading towards a second (to Lehman) and unexpected financial and currency crisis that could happen at any time. I only modify that to say the crisis has indeed begun and it has much further to go this year. This is the background against which we must briefly consider some of the other major currencies, and precious metals.
Japan and the yen
The complacency about Japan in the economic and investment communities is astonishing. Japan is committed to a scale of monetary inflation that if continued can only end up destroying the yen. The Bank of Japan is now financing the equivalent of twice the government deficit (¥41 trillion) by issuing new currency, some of which is being used to buy Japanese equity ETFs and property REITs. By these means pricing in bond, equity and commercial property markets has become irrelevant. “Abenomics” is about financing the government and managing the markets under the Keynesian cover of stimulating both the economy and animal spirits. In fact, with over ¥1.2 quadrillion of public sector debt the government is caught in a debt trap from which it sees no escape other than bluff. And since Abenomics was first embarked upon two years ago, the yen has fallen from 75 to the US dollar to 120, or 37%.
Instead of learning the lessons of previous hyperinflations, mainstream economists fall for the official line and ignore the facts. The facts are simple: Japan is a welfare state with an increasing and unsustainable ratio of retirees to tax-paying workers. She is the leading advanced nation on a debt path the other welfare nations are closely following. Consensus forecasts that the Japanese economy will be stimulated into recovery in 2015 are wide of the mark: instead she is destroying her currency and private sector wealth with it.
Eurozone and the euro
In the short-term the Eurozone is being revisited by its Greek problem. Whether or not the next Greek government backs off from confronting the other Eurozone members and the ECB remains to be seen. The problems for the Eurozone lie considerably deeper than Greece, made worse by politicians who have been reluctant to use the time bought by the ECB to address the structural difficulties of the 19 Eurozone members. The result is the stronger northern bloc (Germany, Netherlands, Finland and Luxembourg) is being crippled by the burden of the Mediterranean states plus Portugal plus France. And Germany and Finland have suffered the further blow of losing valuable export business from Russia.
In the coming months the Eurozone will likely face gas shortages from Russia through the trans-Ukrainian pipeline, and price deflation driven by energy and other commodity prices. Price deflation spurs two further points to consider, one false and the other true: lower prices are deemed to be recessionary (false), and falling prices increase the burden of real debt (true). The consequence is that the ECB will seek ways to expand money supply aggressively to stop the Eurozone from drifting into an economic crisis. In short, the Eurozone will likely develop its own version of Abenomics, the principal difference being the Eurozone’s timeline is behind Japan’s.
US and UK
Japan and the Eurozone account for total GDP of $18.3 trillion, slightly more than the US and added to the emerging and developing economies, gives a total of $48 trillion, or 62% of global GDP for nations leading the world into a slump. So when we consider the prospects for the US and the UK, together producing $20.4 trillion or 26% of the world’s GDP, their prospects are not good either. The UK as a trading nation exposed to the Eurozone has immediate risk, while the US which is not so dependent on international trade, less so.
The foregoing analysis is of the primary economic drivers for 2015 upon which all else will ultimately depend. The risk of a global slump can be called a first order event, while the possibility of a banking crisis, derivatives default or other market dislocation brought on by a slump could be termed a second order event. There is no point in speculating about the possibility and timing of second order events occurring in 2015, because they ultimately depend on the performance of the global economy.
However, when it becomes clear to investors that the global economy is indeed entering a slump, financial and systemic risks are certain to escalate. Judging this escalation by monitoring markets will be difficult because central banks, exchange stability funds and sovereign wealth funds routinely intervene in markets, rendering them misleading as price signals.
Precious metals are the only assets beyond the long-term control of governments. They can distort precious metal markets in the short term by expanding the quantity of derivatives, and there is a body of evidence that these methods have been employed in recent years. But most price distortion today appears to have come from bullion and investment banks who are fully committed to partying in bonds, equities and derivatives, and for which gold is a spoiler. This complacency is bound to be undermined at some point, and a global economic slump is the likely catalyst.
The dangers of ever-inflating currencies are clearly illustrated by the Fiat Money Quantity, which has continued to expand at an alarming rate as shown in the chart below.
FMQ measures the amount of fiat currency issued as a replacement for gold as money, so is a measure of unbacked monetary expansion. At $13.52 trillion last November it is $5.68 trillion above the long-established pre-Lehman crisis growth path, stark evidence of a depreciating currency in monetary terms. Adjusting the price of gold for this depreciation gives a price today the equivalent of $490 in dollars at that time and quantity, so gold has roughly halved in real currency terms since the Lehman crisis.
There is compelling evidence that 2015 will see a global slump in economic activity. This being the case, financial and systemic risks will increase as evidence of the slump accumulates. It can be expected to undermine global equities, property and finally bond markets, which are currently all priced for economic stability. Even though these markets are increasingly controlled by central bank intervention, it is dangerous to assume this will continue to be the case as financial and systemic risks accumulate.
Precious metals are ultimately free from price management by the state. Furthermore, they are the only asset class notably under-priced today, given the enormous increase in the quantity of fiat money since the Lehman crisis.
In short, 2015 is shaping up to be very bad for fiat currencies and very good for gold and silver.
A specter is haunting the world, the specter of two percent inflationism. Whether pronounced by the U.S. Federal Reserve or the European Central Bank, or from the Bank of Japan, many monetary central planners have declared their determination to impose a certain minimum of rising prices on their societies and economies.
One of the oldest of economic fallacies continues to dominate and guide the thinking of monetary policy makers: that printing money is the magic elixir for the creating of sustainable prosperity.
In the eyes of those with their hands on the handle of the monetary printing press the economic system is like a balloon that, if not “fully inflated” at a desired level of output and employment, should be simply “pumped up” with the hot air of monetary “stimulus.”
The Fallacy of Keynesian Macro-Aggregates
The fallacy is the continuing legacy of the British economist, John Maynard Keynes, and his conception of “aggregate demand failures.” Keynes argued that the economy should be looked at in terms of series of macroeconomic aggregates: total demand for all output as a whole, total supply of all resources and goods as a whole, and the average general levels of all prices and wages for goods and services and resources potentially bought and sold on the overall market.
If at the prevailing general level of wages, there is not enough “aggregate demand” for output as a whole to profitably employ all those interested and willing to work, then it is the task of the government and its central bank to assure that sufficient money spending is injected into the economy. The idea being that at rising prices for final goods and services relative to the general wage level, it again becomes profitable for businesses employ the unemployed until “full employment” is restored.
Over the decades since Keynes first formulated this idea in his 1936 book, The General Theory of Employment, Interest, and Money, both his supporters and apparent critics have revised and reformulated parts of his argument and assumptions. But the general macro-aggregate framework and worldview used by economists in the context of which problems of less than full employment continue to be analyzed, nonetheless, still tends to focus on and formulate government policy in terms of the levels of and changes in output and employment for the economy as a whole.
In fact, however, there are no such things as “aggregate demand,” or “aggregate supply,” or output and employment “as a whole.” These are statistical creations constructed by economists and statisticians, out of what really exists: the demands and supplies of multitudes of individual and distinct goods and services produced, and bought and sold on the various distinct markets that comprise the economic system of society.
The Market’s Many Demands and Supplies
There are specific consumer demands for different kinds and types of hats, shoes, shirts, reading glasses, apples, and books or movies. But none of us just demands “output,” any more than there is just a creation of “employment.”
When we go into the marketplace we are interested in buying the specific goods and services for which we have particular and distinct demands. And businessmen and entrepreneurs find it profitable to hire and employ particular workers with specific skills to assist in the manufacture, production, marketing and sale of the distinct goods that we as individual consumers are interested in purchasing.
In turn, each of these individual and distinct goods and services has its own particular price in the market place, established by the interaction of the individual demanders with the individual suppliers offering them for sale.
The profitable opportunities to bring desired goods to market results in the demand for different resources and raw materials, specific types of machinery and equipment, and different categories of skilled and lesser skilled individual workers to participate in the production processes that bring those desired goods into existence.
The interactions between the individual businessmen and the individual suppliers of these factors of production generate the prices for their purchase, hire or employment on, again, multitudes of individual markets in the economic system.
The “macro” economist and his statistician collaborator then proceed to add up, sum and averages all these different individual outputs, employments and specific prices and wages into a series of economy-wide measured aggregates.
But it should be fairly clear that in doing so all the real economic relationships in the market, the actual structure of relative prices and wages, and all the multitude of distinct and interconnected patterns of actual demands and supplies are submerged and lost in the macro-economic aggregates and totals.
Balanced Markets Assure Full Employment
Balanced production and sustainable employments in the economy as a whole clearly requires coordination and balance between the demands and supplies of all the particular goods and services in each of the specific markets on which they are bought and sold. And parallel to this there must be comparable coordination and balance between the businessmen’s demands for resources, capital equipment and different types of labor in each production sector of the market and those supplying them.
Such coordination, balance, and sustainable employment requires adaptation to the every-changing circumstance of market conditions through adjustment of prices and wages, and to shifts in supplies and demands in and between the various parts and sectors of the economy.
In other words, it is these rightly balanced and coordinated patterns between supplies and demands and their accompanying structures of relative prices and wages that assure “full employment” and efficient and effective use of available resources and capital, so entrepreneurs and businessmen are constantly and continuously tending to produce the goods we, the consumers, want and desire, and at prices that are covering competitive costs of production.
All this is lost from view when reduced to that handful of macro-aggregates of “total demand” and “total supply” and a statistical average price level for all goods relative to a statistical average wage level for all workers in the economy.
The Keynesian Government “Big Spender”
In this simplified and, indeed, simplistic view Keynesian-type view of things all that needs to be done from the government’s policy perspective is to run budget deficits or create money through the banking system to push up “aggregate demand” to assure a targeted rise in the general price level so profit-margins “in general” are widened relative to the general wage level so employment “in general” will be expanded.
We can think of government as a “big spender” who comes into a town and proceeds to increase “aggregate demand” in this community by buying goods. Prices for final output rise, profit margins are widened relative to the general wage level and other general cost-prices. Private businesses, in general, employ more workers, purchase or hire other inputs, and “aggregate supply” expands to a point of desired “full employment.”
The presumption on the part of the center bankers in targeting a rate of an average annual price inflation of two percent is that while selling prices are to be pushed up at this average annual rate through monetary expansion, the average level of cost prices (including money wages in general) will not rise or not by the same percentage increase as the average increase in the “price level.”
If cost prices in general (including money wages) were to rise at the same rate as the price level, there would be no margin of additional profits to stimulate greater aggregate output and employment.
Market Anticipations Undermine Keynes’ Assumptions
The fallacy in thinking that cost-prices in general will permanently lag behind the rate of increase in the price level of final goods and services was pointed out long ago, in 1898, by the famous Swedish economist, Knut Wicksell:
“If a gradual rise in prices, in accordance with an approximately known schedule, could be reckoned on with certainty, it would be taken into account in all current business contracts; with the result that its supposed beneficial influence would necessarily be reduced to a minimum.
“Those people who prefer a continually upward moving to a stationary price level forcibly remind one of those who purposely keep their watches a little fast so as to be more certain of catching their train. But to achieve their purpose they must not be conscious or remain conscious of the fact that their watches are fast; otherwise they become accustomed to take the extra few minutes into account, and so after all, in spite of their artfulness, arrive too late . . .”
The Government “Big Spender” Unbalances Markets
But the more fundamental error and misconception in the macro-aggregate approach is its failure to appreciate and focus on the real impact of changes in the money supply that by necessity result in an unsustainable deviation of prices, profits, and resources and labor uses from a properly balanced coordination, the end result of which is more of the very unemployment that the monetary “stimulus” was meant to cure.
Let’s revert to our example of the “big spender” who comes into a town. The townspeople discover that our big spender introduces a greater demand into the community, but not for “goods in general.” Instead, he announces his intention of building a new factory on the outskirts of the town.
He leases a particular piece of land and pays for the first few months rent. He hires a particular construction company to build the factory, and the construction company in turn increases its demand not only for workers to do the work, but orders new equipment, that, in turn, results in the equipment manufacturers adding to their workforce to fulfill the new demand for construction machinery.
Our big spender, trumpeting the wonders for the community from his new spending, starts hiring clerical staff and sales personal in anticipation of fulfilling orders once the factory is completed and producing its new output.
The new and higher incomes earned by the construction and machinery workers, as well as the newly employed clerical and sales workers raise the demand for various and specific consumer and other goods upon which these people want to spend their new and increased wages.
The businesses in the town catering to these particular increased consumer demands now attempt to expand their supplies and, perhaps, hire more retail store employees.
Over time the prices of all of these goods and services will start to rise, but not at the same time or to the same degree. They will go up in a temporal sequence that more or less tends to match the pattern and sequence of the changed demands for those goods and services resulting from the new money injected by the “big spender” into this community.
Inflationary Spending Has to Continue and Increase
Now, whether some of the individual workers drawn into this specific pattern of new employments were previously unemployed or whether they had to be attracted away from existing jobs they already held in other parts of the market, the fact remains that their continued employments in these particular jobs is dependent on the “big spender” continuing to inject and spend his new money, period-after-period of time, in the same way and in sufficient amounts of dollar spending to assure that the workers he has drawn into his factory project are not attracted to other employments due to the rise in all of these alternative or other demands, as well.
If the interdependent patterns of demands and supplies, and the structure of interconnected relative prices and wages generated by the big spender’s spending are to be maintained, his injection of new money into the community must continue, and at an increasing rate of spending if they are not be fall apart.
An alternative imagery might be the dropping of a pebble or stone into a pond of water. From the epicenter where the stone has hit the surface of the water a sequence of ripples will be sent out which will be reversed when the ripples finally hit the surrounding shore, and will then finally come to rest when there is no longer any new disturbances affecting the surface of the pond.
But if the pattern of ripples created are to be sustained, new pebbles or stones must be continuously dropped into the pond and with increasing force if the resulting counter-waves coming back from the shore are not to disrupt and overwhelm the ripple pattern moving out from the original epicenter.
The “Austrian” Analysis of Inflation
It is no doubt that this way of analyzing and understanding the dynamics of how monetary expansion affects market activities is more complex and complicated than the simplistic Keynesian-style of macro-aggregate analysis. But as the famous Austrian-born economist, Joseph A. Schumpeter emphasized:
“The Austrian way of emphasizing the behavior or decisions of individuals and of defining the exchange value of money with respect to individual commodities rather than with respect to a price level of one kind or another has its merits, particularly in the analysis of an inflationary process; it tends to replace a simple but inadequate picture by one which is less clear-cut but more realistic and richer in results.”
And, indeed, it is this “Austrian” analysis of monetary expansion and its resulting impact on prices, employment and production, especially as developed in the 20th century by Ludwig von Mises and Friedrich A. Hayek, that explains why the Keynesian-originated macro-aggregate approach is fundamentally flawed.
As Hayek once explained the logic of the monetary inflationary process:
“The influx of the additional money into the [economic] system always takes place at some particular points. There will always be some people who have more money to spend before the others. Who these people are will depend on the particular manner in which the increase in the money stream is being brought about . . .
“It may be spent in the first instance by government on public works or increased salaries, or it may be first spent by investors mobilizing cash balances for borrowing for that purpose; it may be spent in the first instance on securities, or investment goods, on wages or on consumers’ goods . . .
“The process will take very different forms according to the initial source or sources of the additional money stream . . . But one thing all these different forms of the process will have in common: that the different prices will rise, not at the same time but in succession, and that so long as the process continues some prices will always be ahead of others and the whole structure of relative prices therefore will be very different from what the pure theorist describes as an equilibrium position.”
An inflationary process, in other words, brings about distortions, mismatches, and imbalanced relationships between different supplies and demands, and the relationships between the structure of relative prices and wages that only last for as long as the inflationary process continues, and often only at an accelerating rate.
Or as Hayek expressed it on a different occasion:
“Any attempt to create full employment by drawing labor into occupations where they will remain employed only so long as the [monetary and] credit expansion continues creates the dilemma that either credit expansion must continue indefinitely (which means inflation), or that, when it stops unemployment will be greater than it would be if the temporary increase in employment had never taken place.”
The Inflationary “Cure” Creates More Market Problems
Once the inflationary monetary expansion ends or is slowed down, it is discovered that the artificially created supply and demand patterns and relative price and wage structure are inconsistent with non-inflationary market conditions.
In our example of the “big spender,” one day the townsfolk discover that he was really a con artist who had only phony counterfeit money to spend, and whose deceptive promises and temporary spending drew them into in all of those specific and particular activities and employments. They now find out that the construction projects began cannot be completed, the employments created cannot be maintained, and the investments started in response to the phony money the big spender injected into this community cannot be completed or continued.
Many of the townspeople now have to stop what they had been doing, and try to discover other demanders, other employers and other possible investment opportunities in the face of the truth of the big spenders false incentives to do things they should not have been doing from the start.
The unemployment and under utilization of resources that “activist” monetary policy by governments are supposed to reduce, in fact, set the stage for an inescapable readjustment period of more unemployment and temporary idle resources, when many of the affected supplies and demands have to be rebalanced at newly established market-based prices if employments and productions are to be sustainable and consistent with actual consumer demands and the availability of scarce resources in the post-inflationary environment.
Thus, recessions are the inevitable result from prior and unsustainable inflationary booms. And even the claimed “modest” and “controlled” rate of two percent annual price inflation that has become the new panacea for economic stability and growth in the minds of central bankers, brings in its wake a “wrong twist” to many of the micro-economic supply and demand and price-wage relationships that are the substance of the real economy beneath the superficial macro-aggregates.
Governments and their monetary central planners, therefore, are the cause and not the solution to the instabilities and hardships of inflations and recessions. To end them, political control and manipulation of the money and banking systems will have to be abolished.
[This piece first appeared here: http://www.epictimes.com/richardebeling/2014/12/the-false-promises-of-two-percent-price-inflation/]
Each commodity market has its own story to tell: oil prices are falling because OPEC can’t agree production cuts, steel faces a glut from overcapacity, and even the price of maize has fallen, presumably because of good harvests.
In local currencies this is not so much the case. Of course, the difference between prices in local currencies and prices in US dollars is reflected in the weakness of most currencies against the dollar in the foreign exchange markets. This tells us that whatever is happening in each individual commodity and in each individual currency the common factor is the US dollar.
This is obvious perhaps, but the fall in commodity prices and the rise in the US dollar have to be seen in context. We should note that for most of the global population, the concern that we are facing global deflation (by which is commonly meant falling prices) is not yet true. Nor is a conclusion that the fall in the oil price indicates a sudden collapse in demand for energy. When the dollar price of oil began to slide, so did the exchange rates for all the other major currencies, confirming a significant part of oil’s price move came from dollar strength, which would have also been true of commodity prices generally.
All we can say is that on average there has been a shift of preferences towards holding dollars and away from holding commodities. Looked at in this light we can see that a trend of destocking can develop solely for financial rather than business reasons, because businesses which account in dollars face financial losses on excess inventory. It is the function of speculators to anticipate these decisions, which is what we have seen in recent months.
Macro-economists, who are Keynesian or monetarist by definition, are beginning to interpret falling commodity prices and a rising dollar as evidence of insufficient aggregate demand, which left unchecked will lead to deflation, increasing unemployment, bankruptcies, falling asset prices, and bank insolvencies. It is, they say, an outcome to be avoided at all costs by ensuring that aggregate demand is stimulated so that none of this happens.
Whether or not they are right in this assessment is not the point. They neglect to allow that some of the move in commodity prices is due to the currency itself as the numéraire of all prices.
For evidence of this we need look no further than the attitude of the Fed and every other central bank that targets price inflation as part of their monetary policy. In forming monetary policy there is no allowance for the possibility, nay likelihood, that in future there will be a change in preferences against the dollar, or any other currency for that matter, and in favour of anything else. The tragedy of this lack of market comprehension is that it’s a fair bet that monetary policy will not only succeed in limiting the rise of the dollar as it is designed to do, but end up undermining it when preferences shift the other way.
The moral of the story is that the Fed may be able to fool some of the people all of the time and all of the people some of the time, but worst of all they are fooling themselves. And we should bear in mind that dollar strength is only a trend which can easily reverse at any time.
[Editor’s Note; this interview, with Cobden Centre contributor Jesus Huerta de Soto, was by Malte Fischer of Handelsblatt]
Professor Huerta de Soto, the inflation rate in the euro zone is now only 0.4 percent. Is deflation threatening us, as many experts maintain?
Deflation means that the money supply is shrinking. This is not the case in the euro zone. The M3, the broadly defined supply of money, is growing by about two percent, while the more narrowly defined money supply, M1, by more than six percent. Although the inflation rate in the euro zone is below the European Central Bank’s target of barely two percent, that’s no reason to stir up fears of deflation like some central bankers are doing.
By doing so, they are suggesting that lowering prices is something bad. That is wrong. Price deflation is not a catastrophe, but rather a blessing.
You’ll have to explain that.
Take my homeland, Spain. At the moment, the consumer prices there are decreasing. At the same time, the economy is growing by around two percent on a yearly basis. Some 275,000 new jobs were created in 2013 and unemployment fell from 26 to 23 percent. The facts contradict the horror scenarios of deflation.
Does that mean we should be happy about deflation?
Certainly. It is particularly beneficial when it results from an interplay of a stable money supply and increasing productivity. A fine example is the gold standard in the 19th century. Back then, the money supply only grew by one to two percent per year. At the same time, industrial societies generated the greatest increase in prosperity in history. That is why the ECB should use the gold standard as an example and lower the target for the growth of the M3 money supply from 4.5 to around 2.0 percent.
If the euro economy were to grow by about three percent – which it is capable of doing if it were freed from the shackles of state regulations – prices would decrease by about one percent per annum.
If deflation is so beneficial, why are people afraid of it?
I don’t believe that the average person is frightened by falling prices. It is the representatives of mainstream economics fomenting a deflation phobia. They argue that deflation allows the actual debt burden to increase, and thus strangles the overall economic demand. The deflation alarmists fail to mention that creditors benefit from deflation, which stimulates demand.
Isn’t there a danger consumers will roll back their spending if everything is cheaper tomorrow?
That is an abstruse argument you hear again and again. Look at how fast the latest smartphones sell, although consumers know that the phones will be sold at a lower cost a few months afterwards. America was dominated by deflation for decades after the Civil War. In spite of that, consumption increased. If people were to put off buying because of lower prices, they ultimately would starve to death.
But lowering prices drives down sales figures and lessens the willingness of companies to invest. Do you want to ignore that?
Sales figures are not crucial for companies, but rather their earnings, meaning the difference between revenues and costs. Sinking sales prices increase pressure to reduce costs. The companies, therefore, replace manpower with machines. That means more machines need to be produced, which increases the demand for manpower in the capital goods sector. In this way, workers who lost their jobs in the wake of price deflation find new work in the capital goods sector. The capital stock grows without resulting in mass unemployment.
Aren’t you making that too easy for yourself ? In reality, the gap between the qualifications of the unemployed and the needs of companies is, at times, quite large.
I’m not claiming the market is perfect. That means it’s crucial that the labor market is flexible enough to offer incentives for creative employers to hire new workers.
What role does politics play?
The problem is that politicians have a short time horizon. That is why we need a monetary policy framework that holds both politicians and unions in check. The euro has this job in Europe. The common currency has removed the option of governments to devalue the currency to cover for their misguided economic policies. Economic policy mistakes are seen directly in the affected country’s loss of competitiveness, which forces politicians to make harsh reforms. Two governments in Spain within one and half years have implemented reforms that I hadn’t even dared to dream of. Now, the economic situation is improving and Spain is reaping the harvest of the reforms.
You may be right in the matter of Spain, but there have been no signs of fundamental reforms in Italy and France…
Which is why conditions there will first have to get worse before reforms come. We have learned from experience that the more miserable the economic situation, the stronger the pressure to reform. The reform successes that Spain and other euro countries have achieved increase the pressure on Paris and Rome. High unemployment in Spain had pushed down labor costs. At an average of €20, or $24.90, per hour, they are now half the rate as in France. That is why the French cannot avoid a drastic economic policy cure, even if the people oppose it. Germany should hold to its budgetary consolidation to keep up pressure on France and Italy.
The ECB is coming under increasing pressure to open the monetary floodgates and devalue the euro. The pressure is coming from academics, financial markets and politicians.
The economic mainstream of Keynesianism and monetarism explains the Great Depression of the 1930s with a shortage of money, which allowed an anti-deflation mentality to develop among academics. Politicians use the academic sounding board to pressure the ECB to reinflate the economy. Governments love inflation because it gives them the opportunity to live beyond their means and pile up huge mountains of debt that the central bank devaluates through inflation. It is no wonder it just happens to be the opponents of austerity policies who warn about deflation and demonize the euro’s set of stability policy regulations. They are afraid of presenting the true costs of the welfare state to the electorate.
The head of the ECB, Mario Draghi, succumbed to the pressure with his promise to save the euro if needs be by firing up the money printing presses. A mistake?
Careful. Until now, Mr. Draghi has been mainly making promises, but has barely acted. Although the ECB has initiated generous money lending transactions, and lowered the prime lending rate, the actual yield for 10-year government bonds of ailing euro zone members is above those in America. Measured on the balance sheet totals, the ECB has done less than other Western central banks. As long as the guardians of the euro are only talking but not acting, the pressure will remain on Italy and France to reform. That is why it is crucial the ECB resists the pressure of the governments and the Anglo-Saxon financial world and buys no state bonds.
What role do the Anglo-Saxon financial markets play?
The Anglo-Saxon press and the financial markets are ostentatiously conducting a crusade against the euro and the austerity policy in continental Europe necessitated by it. I am really no believer in conspiracy theories, but the out-and-out attacks against the euro by Washington and London suggest a hidden agenda. The Americans are afraid that the days of the dollar as a global currency are numbered if the euro survives as a hard currency.
Can the euro survive without political union?
A political union will not draw majority support in the population. It also isn’t desirable because it reduces the pressure for fiscal austerity. The best monetary regime for a free society is the gold standard, with all deposits covered by full reserves and without state central banks. As long as we don’t have that, we should defend the euro because it deprives governments of access to the money printing presses and forces them to consolidate their budgets and make reforms. In a certain way, it has the effect of the gold standard.
[Editor’s Note: this piece, by Lewis E. Lehrman And John D. Mueller, first appeared in the Wall Street Journal http://online.wsj.com/articles/how-the-reserve-dollar-harms-america-1416527644. It was kindly brought to our attention by Cobden Centre contributor Ralph Benko.]
For more than three decades we have called attention on this page to what we called the “reserve-currency curse.” Since some politicians and economists have recently insisted that the dollar’s official role as the world’s reserve currency is instead a great blessing, it is time to revisit the issue.
The 1922 Genoa conference, which was intended to supervise Europe’s post-World War I financial reconstruction, recommended “some means of economizing the use of gold by maintaining reserves in the form of foreign balances”—initially pound-sterling and dollar IOUs. This established the interwar “gold exchange standard.”
A decade later Jacques Rueff, an influential French economist, explained the result of this profound change from the classical gold standard. When a foreign monetary authority accepts claims denominated in dollars to settle its balance-of-payments deficits instead of gold, purchasing power “has simply been duplicated.” If the Banque de France counts among its reserves dollar claims (and not just gold and French francs)—for example a Banque de France deposit in a New York bank—this increases the money supply in France but without reducing the money supply of the U.S. So both countries can use these dollar assets to grant credit. “As a result,” Rueff said, “the gold-exchange standard was one of the major causes of the wave of speculation that culminated in the September 1929 crisis.” A vast expansion of dollar reserves had inflated the prices of stocks and commodities; their contraction deflated both.
The gold-exchange standard’s demand-duplicating feature, based on the dollar’s reserve-currency role, was again enshrined in the 1944 Bretton Woods agreement. What ensued was an unprecedented expansion of official dollar reserves, and the consumer price level in the U.S. and elsewhere roughly doubled. Foreign governments holding dollars increasingly demanded gold before the U.S. finally suspended gold payments in 1971.
The economic crisis of 2008-09 was similar to the crisis that triggered the Great Depression. This time, foreign monetary authorities had purchased trillions of dollars in U.S. public debt, including nearly $1 trillion in mortgage-backed securities issued by two government-sponsored enterprises, Fannie Mae and Freddie Mac. The foreign holdings of dollars were promptly returned to the dollar market, an example of demand duplication. This helped fuel a boom-and-bust in foreign markets and U.S. housing prices. The global excess credit creation also spilled over to commodity markets, in particular causing the world price of crude oil (which is denominated in dollars) to spike to $150 a barrel.
Perhaps surprisingly, given Keynes ’s central role in authoring the reserve-currency system, some American Keynesians such as Kenneth Austin, a monetary economist at the U.S. Treasury; Jared Bernstein, an economic adviser to Vice President Joe Biden ; and Michael Pettis, a Beijing-based economist at the Carnegie Endowment, have expressed concern about the growing burden of the dollar’s status as the world’s reserve currency. For example, Mr. Bernstein argued in a New York Times op-ed article that “what was once a privilege is now a burden, undermining job growth, pumping up budget and trade deficits and inflating financial bubbles.” He urged that, “To get the American economy on track, the government needs to drop its commitment to maintaining the dollar’s reserve-currency status.”
Meanwhile, a number of conservatives, such as Bryan Riley and William Wilson at the Heritage Foundation, James Pethokoukis at the American Enterprise Institute and Ramesh Ponnuru at National Review are fiercely defending the dollar’s reserve-currency role. Messrs. Riley and Wilson claim that “The largest benefit has been ‘seignorage,’ which means that foreigners must sell real goods and services or ownership of the real capital stock to add to their dollar reserve holdings.”
This was exactly what Keynes and other British monetary experts promoted in the 1922 Genoa agreement: a means by which to finance systemic balance-of-payments deficits, forestall their settlement or repayment and put off demands for repayment in gold of Britain’s enormous debts resulting from financing World War I on central bank and foreign credit. Similarly, the dollar’s “exorbitant privilege” enabled the U.S. to finance government deficit spending more cheaply.
But we have since learned a great deal that Keynes did not take into consideration. As Robert Mundell noted in “Monetary Theory” (1971), “The Keynesian model is a short run model of a closed economy, dominated by pessimisticexpectations and rigid wages,” a model not relevant to modern economies. In working out a “more general theory of interest, inflation, and growth of the world economy,” Mr. Mundell and others learned a great deal from Rueff, who was the master and professor of the monetary approach to the balance of payments.
Those lessons are reflected in the recent writings of Keynesians such as Mr. Austin, who has outlined what he calls the “iron identities” of international payments, which flow from the fact that global “current accounts, global capital accounts, and global net reserve sales, must (and do) sum to zero.” This means that a trillion-dollar purchase, say, of U.S. public debt by the People’s Bank of China entails an equal, simultaneous increase in U.S. combined deficits in the current and capital accounts. The iron identities necessarily link official dollar-reserve expansion to the declining U.S. investment position.
The total U.S. international investment position declined from net foreign assets worth about 10% of gross domestic product in 1976 to minus-30% of GDP in 2013—while the books of U.S. private residents went from 10% of U.S. GDP in 1976 down to balance with the rest of the world in 2013. The entire decline in the U.S. net international investment position was due to federal borrowing from foreign monetary authorities—i.e., government deficit-financing through the dollar’s official reserve-currency role.
Ending the dollar’s reserve-currency role will limit deficit financing, increase net national savings and release resources to U.S. companies and their employees in order to remain competitive with the rest of the world.
Messrs. Riley and Wilson argue that “no other global currency is ready to replace the U.S. dollar.” That is true of other paper and credit currencies, but the world’s monetary authorities still hold nearly 900 million ounces of gold, which is enough to restore, at the appropriate parity, the classical gold standard: the least imperfect monetary system of history.
Messrs. Lehrman and Mueller are principals of LBMC LLC, an economic and financial market consulting firm. Mr. Lehrman is the author of “The True Gold Standard: A Monetary Reform Plan Without Official Reserve Currencies” (TLI Books, 2012). Mr. Mueller is the author of “Redeeming Economics: Rediscovering the Missing Element” (ISI Books, 2014).