|
|
By Toby Baxendale, on 8 October 11
Who made this very sound statement two years ago in relation to QE I?
The last resort of desperate governments when all other policies have failed
Answer: George Osborne, our Chancellor.
Sometime soon it will have to stop because in the end printing money leads to inflation.
Answer: our Prime Minister.
Both of these statements were made in 2009 when the first round of QE unfolded.
If people are spending less, it follows that the money unit is being used less. Indeed corporate balance sheets are paying down debt and chalking up healthy cash balances. Coupled with this, in a fractional reserve system, when money gets repaid and not relent, as we know, it came from nothing, and it goes back to nothing.
Personal savings are at their highest for many years as households do the same, pay off debt and replenish cash balances.
Bank reserves are the highest they have been for a long time in relation to overall bank balance sheet size.
God help us if people do start to spend again in the fashion of old as there will be the mother of all inflations.
By the way, many empirical studies, most notably by Friedman, show us that the demand for money is very stable.
As we have discussed here before, regime policy uncertainty will cause people to hold precautionary balances, but only for a short period of time.
With the first round of QE of £200bn and now the second of £75bn we have nearly added 15% to the money supply.
They way out for the Bank of England is to massively raise interest rates as part of a very tight money policy. Either way, this is bad news for us.
Hoping a mild inflation will reduce our real debts over time is a very dangerous game. As soon as the inflation genie is out of the bottle, and we all realise that our money is depreciating, we will spend it, retailers will reprice to take into account the new demand, and prices will soar.
They are hoping not only for a mild inflation, but also for those in receipt of the new money, the people who have had their gilts bought with the new money, to then go and spend it and get those “animal spirits” working again.
So the bankers once again win. More expensive houses, more fast cars and boats, with their bonuses for organizing the buying of the gilts.
The banks get the new money deposited with them and can then shore up their balance sheets even further, as I suspect they are still concerned about all the wonky property loans and dodgy sovereign debt they need to wipe off their books. Thus, giving effectively £75bn of money out of the ether to the banks will not have the desired effect of increasing lending or spending (besides the bankers’ toys already mentioned). We all just have our purchasing power diminished while that of the banking system is raised. They get the new wealth effect, not you!
As most of these institutions are replete with failed corporate executives, still in the same jobs, who will more than likely repeat the same mistakes, who are regulated by the same people in differently named organizations, we have once more a recipe for disaster.
As we always say on this site, the creditors get fleeced . A pensioner buying an annuity today with a £300k pension would have got £22,500 pa and now will get £18,500, should the yields go down to where they want it. The ongoing war on the poor is relentless. Pensioners just have to swallow a 30% pay cut. Forget looters in Tottenham, we will have geriatrics in the streets of green and leafy middle class suburbia smashing the place up if they are not careful. They will suffer for the mistakes of past governments who in partnership with the banks created the mother of all credit booms, which has led to the largest misallocation of resources since the 30s.
As blame for the artificial boom does not lie with the Conservative Party, but with the Blair and Brown money regimes, I can’t fathom why the current government keeps trying to repeat the policy mistakes of the previous one, especially when they condemned this approach to money policy back in 2009.
One further thing, if they do pull yields down on gilts, this may well make borrowing costs marginally cheaper, but lets face it: if 50 basis points means you live or die in business, you are kidding yourself that you have a viable business anyway.
Likewise, if you are a home owner who is so close to the wire that a fraction of a interest rate move wipes you out, then you are a renter of a home, not an owner. The quicker you default, then better for you and your family. Release your burden, rent, and feed your family. No one will be saying at your funeral “he was a great man, he honoured his mortgage. Even though he never should have taken it out because he could not afford it, he was advised by the bank to do so. What’s more, they were so kind that they gave him a mortgage worth more than the house, so he could buy his furniture. Failing to feed his kids and getting divorced did not trouble this honorable man; for the rest of his life he toiled for the bank.”
Embrace default and let’s get this correction over and done with, so we can carry on and rebuild our lives in peace.
By Sean Corrigan, on 11 September 11
A Modest Craft – Sept 12, 2001
It is at times like these that we in the financial sector are humbled in the presumption of our own importance and of the meaning of our works. Daily, we chase the ebb and flow of symbols and numbers across the screens and ticker tapes of the world, seeking to distill from them a fleeting pattern, or to recognize within them some more enduring form.
Rarely, if ever, amid the hubbub of the trading room or the raw intensity of the Pit, do we reflect on the power of such symbols. We crane for each flickering change in a terse alphanumeric—USZ1, DELL, CPI +0.2%, DAX +150—each of us striving uselessly, but compulsively, to see it before our peers do, or, with a little more purpose, to interpret it more quickly than they.
These electronic lights represent a stock, a bond, a currency; of that much we remain aware. But the stocks or bonds themselves are but symbols: a claim to the ownership of a minuscule fraction of some sprawling enterprise, or a right to receive payment from it in days to come.
Again, that payment—in dollars, or euros, or yen—is another symbol: a sign that men have “laboured the earth,” in Jefferson’s trenchant phrase, and that they seek to exchange the fruits of those labours for our own.
This is where the chain of ciphers and sigils leads us at last, then—to the efforts of ordinary men and women going about their daily lives, working at one thing, the thing at which they are most competent, in order to swap their efforts for other things, for a whole diversity of things, made, in turn, by countless, faceless others doing what they are good at, too.
By such free and open exchange, best conducted using fair and honest chains of symbols so that no man is unwittingly deluded or knowingly defrauded in the act, we each seek to serve our enlightened self-interest and satisfy both basic needs and wider aspirations. We find the opportunity where we are most rewarded, and we send out our labours into the vast, teeming, immaterial, immanent Market that is our world.
And—O Mirabile—what things come back, in what profusion, pouring in from all corners of the globe, from people we have never seen, whom we will never see, and who equally are oblivious to our very existence also.
This is the majesty of the free market, of capitalism, this self-organizing scheme that most fully utilizes our jewelled planet’s greatest resource—humanity itself—so that the masses of today live better than all the fearsome khans and haughty emperors of old.
But on Tuesday, out of a clear autumnal sky, all this was put at deadly hazard by earnest men, albeit men whose earnestness had been twisted into suicidal hatred by the potent brew of fanaticism and despair. By their intricate assault on the good people of the U.S., these men showed that they were versed in the power of symbols all too well.
To attack the Pentagon—a cabbalistic form, if ever there was one—was shocking enough, displaying what guerrilla fighters have shown from time immemorial: that all of Caesar’s legions cannot guard against the man who fears nothing but to fail, and who holds his life most gloriously spent in depriving his enemies of theirs.
But far more shocking yet was the strike deep into the very heart of trade, of commerce, and of finance that those few crammed canyons of soaring steel and glittering glass at the tip of Manhattan represented, not just to America, but to the entire world. This was not just an abomination: in many ways, it was a deliberate act of sacrilege.
In tens of minutes, before unbelieving eyes staring from the streets below or gazing in horrid fascination at TV screens across the globe, fireball billowed into smoke and then collapse: crushing, utter, complete and roaring collapse.
As though struck from where they stretched unto the very portals of some jealous god to choking dust and stumbling rubble, they fell in ruinous descent, and Hope itself seemed perished.
The Twin Towers, standing symbolically over Wall Street, were a 1,300-foot rendition of those two, short verticals that transform a mere “S” into a dollar, transmuting it to a symbol for work and wealth and well-being across the Earth.
The enormity of the towers’ swift destruction has been such as to suspend analysis. We have yet to truly register what has been done, how many lives have been lost in screaming (if mercifully brief) terror, how many countless other lives will bear the mark of what was wrought, shivering in the cold snatch of fear each time they see the suddenly naked skyline of New York.
It would be heartening to think that sober wisdom will now occasion restraint in the councils of the powerful, that the understandable desire for retribution, for lex talionis, to be invoked neither will lead to rash and unjust acts that only serve to excite more hatred, nor open up the way for the ever-eager State to intrude more insidiously in people’s lives at home, while snarling ever more belligerently at foes—real or imagined—abroad.
It would be heartening to believe that in America of all nations, the brash, young, self-confidence of its people will swiftly reassert itself, that temperance will season justice, and that this brief, vicarious brush with mortality will give rise to a more measured outlook on life.
It would be heartening to think that, having been shocked by just how fragile is the framework on which we build our dreams, we will become less prone to forcing them upon others. Our fear must be that, in a world already made fractious and divided by the inexorable, UN-inspired, left-liberal-sanctioned politicizing of race and creed and gender, a world made insecure by the erosion of freedom and the imposition of alien values by the Guardians of our global Platonic republic, yet more discord is sown.
We must also fear that, in a world made resentful by seeing the fruits of its labours channelled to vainglorious corporate demi-gods who strut the stage like Achilles simply because a hyperactive credit system has grossly inflated their stock price, Capitalism is made to take the blame.
Capitalism is about the better production of wealth and its distribution through unrestricted exchange. It is about the multiplication of output that comes about by the division of labour. It is about the preservation of capital—those mental and physical tools that build each successive flight on our long stairway out of penury and deprivation—and it achieves that preservation only by the common virtue of thrift and the duty of stewardship on one hand, and by the banishment of envy and the sanctity of property upon the other.
Capitalism is about “labouring the earth” more fruitfully so that fewer men go needy, so that the next fanatic finds less willing recruits, so that amid bustling commercial intercourse, barriers of class and race and ignorance are dissolved into mutual respect and benefit.
Capitalism is nothing to do with the agents of the Crown who sail alongside the honest argosies of trade. Capitalism is nothing to do, either, with the forced acceptance of any creed or code of law, save that of the honest self-interest by which both buyer and seller achieve an increment of value in their exchange.
For we must realize that Capitalism, this most certain route to prosperity devised by man, is also the victim of the exactions of the State and the depredations of the credit system. Why else, even before yesterday’s barbaric deeds, were we increasingly in peril of our livelihoods, our investments, and our savings?
Sadly, that is a verity too rarely glimpsed when the battle ensigns of the fleet and the Jolly Rogers of the corsairs are concealed amid the merry, ingenuous bunting of the mass of ordinary merchantmen seeking innocently to ply their trade.
From this passing meditation on these matters, which this week’s dark happenings have prompted, we shall soon return to the business of chasing symbols and trying to make sense of them. That is, after all, our modest craft in the rich whirl of the market.
For today, we pray for the maimed and the bereaved. We are anxious for the path of the economy and our immediate prosperity. We fret that liberty will once again be the most enduring loser.
In memoriam,
Sean Corrigan
Chief Investment Strategist
Diapason Commodities Management S.A.
By Toby Baxendale, on 19 August 11
FT – Bullion bulls talk of $5000 gold
Historically, gold and silver were the money of choice, freely chosen by the people as the most marketable commodities. The value of your labour was measured in these precious metals.
Wicked Kings through the ages debased the people’s money for their own profit. The last English king to do this was Henry VIII. Our money was free from debasement for many years thereafter; the value of our work undebauched.
Today, governments around the world assume the powers of kings of old as they embark on the “monetisation” of their debt, minting new money from nowhere. They call it QE.
Since 1971, when Nixon severed the last link to gold (struggling to pay for the latest war), paper currencies have been the most extreme derivatives, resting on a mere memory of underlying value. CDO squared has nothing on paper fiat.
So the people are voting with their feet, and returning to ancient currency — to gold and silver.
How much does an ounce of gold buy you today? $1800 worth of goods and services. And a year ago? $1200 worth of goods and services. How much purchasing power been taken away from you?
How long will governments around the world, with no political will to tackle their dangerous debts and zombie banks, be able to maintain confidence in their paper systems? I do not know, but I feel that we’re fast approaching a day when the whole western monetary system will fundamentally change.
I hope the new paper will be redeemable in gold or silver. Governments can’t mint this stuff up like magic. They will be forced to raise money through taxation alone, according to what the public will bear. No longer will they be able to kick the can down the road, while stealthily confiscating the fruits of our labour.
I am delighted that even the FT, that stalwart of conventional economics, is now asking ‘how high could gold go?‘. Let us hope they consider the fundamentals, and recall our long, sorry history of debasement.
By Anita Acavalos, on 1 July 11
It is with no feelings of joy that we republish this article, first posted on 8 February 2010
Guest contributor Anita Acavalos, daughter of Advisory Board member Andreas Acavalos, explains the political and economic predicament in Greece.
In recent years, Greece has found itself at the centre of international news and public debate, albeit for reasons that are hardly worth bragging about. Soaring budget deficits coupled with the unreliable statistics provided by the government mean there is no financial newspaper out there without at least one piece on Greece’s fiscal profligacy.
Although at first glance the situation Greece faces may seem as simply the result of gross incompetence on behalf of the government, a closer assessment of the country’s social structure and people’s deep-rooted political beliefs will show that this outcome could not have been avoided even if more skill was involved in the country’s economic and financial management.
The population has a deep-rooted suspicion of and disrespect for business and private initiative and there is a widespread belief that “big money” is earned by exploitation of the poor or underhand dealings and reflects no display of virtue or merit. Thus people feel that they are entitled to manipulate the system in a way that enables them to use the wealth of others as it is a widely held belief that there is nothing immoral about milking the rich. In fact, the money the rich seem to have access to is the cause of much discontent among people of all social backgrounds, from farmers to students. The reason for this is that the government for decades has run continuous campaigns promising people that it has not only the will but also the ABILITY to solve their problems and has established a system of patronages and hand-outs to this end.
Anything can be done in Greece provided someone has political connections, from securing a job to navigating the complexities of the Greek bureaucracy. The government routinely promises handouts to farmers after harsh winters and free education to all; every time there is a display of discontent they rush to appease the people by offering them more “solutions.” What they neglect to say is that these solutions cost money. Now that the money has run out, nobody can reason with an angry mob.
A closer examination of Greek universities can be used as a good illustration of why and HOW the government has driven itself to a crossroad where running the country into even deeper debt is the only politically feasible path to follow. University education is free. However, classroom attendance is appalling and there are students in their late twenties that still have not passed classes they attended in their first year. Moreover, these universities are almost entirely run by party-political youth groups which, like the country’s politicians, claim to have solutions to all problems affecting students. To make matters worse, these groups often include a minority of opportunists who are not interested in academia at all but are simply there to use universities as political platforms, usually ones promoting views against the wealthy and the capitalist system as a whole even though they have no intellectual background or understanding of the capitalist structure.
This problem is exacerbated by the fact that there is no genuine free market opposition. In Greece, right wing political parties also favour statist solutions but theirs are criticised as favouring big business. The mere idea that the government should be reduced in size and not try to have its hand in everything is completely inconceivable for Greek politicians of all parties. The government promises their people a better life in exchange for votes so when it fails to deliver, the people naturally think they have the right or even the obligation to start riots to ‘punish’ them for failing to do what they have promised.
Moreover, looking at election results it is not hard to observe that certain regions are “green” supporting PASOK and others “blue” supporting Nea Dimokratia. Those regions consistently support certain political parties in every election due to the widespread system of patronages that has been created. By supporting PASOK in years where Nea Dimokratia wins you can collect on your support when inevitably after a few election periods PASOK will be elected and vice versa. Not only are there widely established regional patronage networks but there are strong political families that use their clout to promise support and benefits to friends in exchange for their support in election years.
Moreover, in line with conventional political theory on patronage networks, in regions that are liable to sway either way politicians have a built in incentive to promise the constituents more than everyone else. The result is almost like a race for the person able to promise more, and thus the system seems by its very nature to weed out politicians that tell people the honest and unpalatable truth or disapprove of handouts. This has led people to think that if they are in a miserable situation it is because the government is not trying hard enough to satisfy their needs or is favouring someone else instead of them. When the farmers protest it is not just because they want more money, it is because they are convinced (sometimes even rightly so) that the reason why they are being denied handouts is that they have been given to someone else instead. It is the combination, therefore, of endless government pandering and patronages that has led to the population’s irresponsible attitude towards money and public finance. They believe that the government having the power to legislate need not be prudent, and when the government says it needs to cut back, they point to the rich and expect the government to tax them more heavily or blame the capitalist system for their woes.
After a meeting in Brussels, current Prime Minister George Papandreou said:
Salaried workers will not pay for this situation: we will not proceed with wage freezes or cuts. We did not come to power to tear down the social state.
It is not out of the kindness of his heart that he initially did not want to impose a pay freeze. It was because doing so would mean that the country may never escape the ensuing state of chaos and anarchy that would inevitably occur. Eventually he did come to the realisation that in the absence of pay freezes he would have to plunge the country into even further debt and increase taxes and had to impose it anyway causing much discontent. Does it not seem silly that he is still trying to persuade the people that they will not pay for this situation when the enormous debts that will inevitably ensue will mean that taxes will have to increase in perpetuity until even our children’s children will be paying for this? This minor glitch does not matter, though, because nobody can reason with a mob that is fighting for handouts they believe are rightfully theirs.
Greece is the perfect example of a country where the government attempted to create a utopia in which it serves as the all-providing overlord offering people amazing job prospects, free health care and education, personal security and public order, and has failed miserably to provide on any of these. In the place of this promised utopian mansion lies a small shack built at an exorbitant cost to the taxpayer, leaking from every nook and cranny due to insufficient funds, which demands ever higher maintenance costs just to keep it from collapsing altogether. The architects of this shack, in a desperate attempt to repair what is left are borrowing all the money they can from their neighbours, even at exorbitant costs promising that this time they will be prudent. All that is left for the people living inside this leaking shack is to protest for all the promises that the government failed to fulfil; but, sadly for the government, promises will neither pay its debts nor appease the angry mob any longer. Greece has lost any credibility it had within the EU as it has achieved notoriety for the way government accountants seem to be cooking up numbers they present to EU officials.
Dismal as the situation may appear, there still is hope. The Greeks many times have shown that it is in the face of dire need that they tend to bond together as a society and rise to the occasion. Family ties and social cohesion are still strong and have cushioned people from the problems caused by government profligacy. For years, the appalling situation in schools has led families to make huge sacrifices in order to raise money for their children’s private tuition or send them to universities abroad whenever possible. This is why foreign universities, especially in the UK, are full of very prominent and hard working Greek students. Moreover, private (as opposed to public) levels of indebtedness, although on the rise, are still lower than many other European countries.
However, although societal bonding and private prudence will help people deal with the consequences of the current crisis, its resolution will only come about if Greek people learn to listen to the ugly truths that sometimes have to be said. They need to be able to listen to statesmen that are being honest with them instead of politicians trying to appease them in a desperate plea to get votes. The time for radical, painful, wrenching reform is NOW.
There are no magic wands, no bail-outs, no quick and easy fixes. The choice is between doing what it takes to put our house in order ourselves, or watching it collapse around us. This can only come about if Prime Minister George Papandreou uses the guts he has displayed in the past when his political stature and authority had been challenged and channels them towards making the changes the country so desperately needs. Only if he emerges as a truly inspired statesman who will choose the difficult as opposed to the populist solution will Greece be up again and on a path towards prosperity. He needs to display a willingness to clean up the mess made after years of bad government and get society to a point where they are willing to accept hard economic truths. One can only hope…
Further reading
By Steven Baker MP, on 1 June 11
From Deception of Government Intervention (1964) – an essay in Mises’ anthology Economic Freedom and Interventionism – we learn how governments adopted “the third way”:
Faced with the tremendous challenge of totalitarianism, the ruling parties of the West do not venture to preserve the system of free enterprise that gave to their nations the highest standard of living ever attained in history. They ignore the fact that conditions for all citizens of the United States and those other countries which have not put too many obstacles in the way of free enterprise are much more favorable than conditions for the inhabitants of the totalitarian countries. They think that it is necessary to abandon the market economy and to adopt a middle-of-the-road policy that is supposed to avoid the alleged deficiencies of the capitalistic economy. They aim at a system which, as they see it, is as far from socialism as it is from capitalism and which is better than either of those two. By direct intervention of the government, they want to remove what they consider unsatisfactory in the market economy.
Such a policy of government interference with the market phenomena was already recommended by Marx and Engels in the Communist Manifesto. But the authors of the Communist Manifesto considered the ten groups of interventionist measures they suggested as measures to bring about step-by-step full socialism. However, in our time the government spokesmen and the politicians of the left recommend the same measures as a method, even as the only method, to salvage capitalism.
In the aftermath of the financial crisis, we are now going down a road towards ‘judgement-based’ regulation of financial firms in an attempt to salvage capitalism.
It is proposed that firms will be supervised by what amount to shadow management teams of disinterested, public-spirited individuals more able to reach sound views than firms’ own management teams: they shall possess “the optimal experience and technical ability”.
Quite where these mythical philosopher kings are to be found, I do not know. Presumably, financial firms and regulators already hire the best people available. And the notion that the best people will work for the regulator despite inevitably higher rewards in the firms themselves is silly.
Financial firms will find their business subject to the day-to-day judgement of government officials. To think that those officials will be more capable than the institutions’ traders and managers is a fantasy. The outcome will be, as it has been, a surprise financial catastrophe as regulators fail to foresee the future and, since they are bound to converge on “best practice”, fail as one.
A free society is not one based on constant official interference with business. It is one based on cooperation, choice, competition, profit & loss, predictable rules fixed well in advance and exit from the market: that is, property, contract and the classical rule of law.
Rather than resort to fantastic ideas about the effectiveness of government interference with market phenomena, we would do better to reapply the principles of a free society. Financial institutions should be no exception, for government intervention caused the crisis [1,2].
Postscript: Marx and Engels’ ten measures are available here.
By James Tyler, on 4 March 11
Another classic article, brought forward. This is a speech by James Tyler to the Adam Smith Institute Next Generation Group on 6 October 2009. This speech is also available on hedgehedge.com.
I have spent the best part of the last two decades pitting my wits against the market. It’s an unforgiving game: I’ve seen ups and downs, and many of my rivals buried under an avalanche of hubris, passion, illogical thought and unchecked emotion.
I have witnessed the sheer folly of the ERM crisis, the Asian crisis, the failure of the Gods at Long Term Capital Management and the insanity of the tech boom.
I have enjoyed the ‘NICE’ decade (Non-Inflationary Constant Expansion), and scared myself silly during the credit crisis.
I am a trader.
I risk my own money and live or die by my decisions, and face the threat of personal bankruptcy every time I switch my screens on. I get no salary – indeed I turn up at the start of the month with a large office overhead – a ‘negative’ salary. I have no fancy company pension scheme, no lucrative monopoly or franchise.
I eat what I kill.
Mistakes cost me my livelihood, so, above all, my decisions have to be rooted in practical and logical decision making.
Some have called my kind parasitic, but I would have said that I bring order, efficiency, predictability, stability and deep liquidity to a crucial process: a process that makes the whole world keep ticking.
I make money work.
I make the market in interest rate derivatives: a market born out of the neo classical revolution in finance fostered in Chicago during the 1970s. I am a child of Friedman, Fisher Black, Myron Scholes and the modern international financial system.
My analysis was steeped in the neo-classical, efficient markets paradigm.
Friedman’s ideal was working. Enlightened central bankers guided the free market with gentle nudges and short term liquidity infusions, free floating currencies gently adjusted themselves to the constant flow of new information and efficient and rational markets took all in their stride.
Credit flowed, people got wealthier, economies developed and all was well.
And then the crisis struck.
Continue reading “My Journey to Austrianism via the City”
By James Tyler, on 1 March 11
A speech to the Policy Exchange on 31st March 2009 by Cobden Centre sponsor James Tyler. This article first appeared on hedgehedge.com but it remains as relevant today.
I want to talk about two things today;
Number 1: Free markets did NOT cause this crisis… Governments did.
Number 2: Inflation targeting has failed. Money has failed. What should we do?
Free markets did not cause this problem.
In theory, markets work by reacting to prices and direct capital towards where it will be most productively used. This is how wealth is created. Usually this works well, but markets are made up of humans, and can be fooled into overshooting by false signals.
Bubbles build up, expanding until people lose confidence. Bubbles then burst. It’s a corrective process that, relatively benignly, irons out imbalances.
The problem only comes when bubbles go on for too long, because once they get too big, the pop can be terrifying. And that’s what we’ve got now – one hell of a big bang.
False signals have caused a spectacular mal-investment in real estate and its derivatives.
But these false signals did not come from the market, but from government.
False signals.
False signals came from Greenspan’s introduction of welfare for markets. Markets were taught that no matter how much risk they took, they would always be saved. 1987, 1994, 1998, 2001. Each bust bigger than the last, and disaster was only staved off with aggressive rate cuts and increased money supply.
Clearly this was not laissez faire. Just think if events had been allowed to take their course. I bet if LTCM had gone bust then a badly burned Wall Street would have learned a lesson and Lehman’s would still be around today.
In 1999 Clinton mandated that Fannie Mae and Freddie Mac reduce lending standards. The poor were encouraged into debt. This intervention triggered a race to the bottom of lending standards as commercial banks were forced to compete against the limitless pockets of Uncle Sam.
False signals came from deposit insurance. Deposit your money in a boring mutual? Why bother when you can lend it to a lump of volcanic rock in the Atlantic at 7% and be guaranteed to get your money back.
The Basle banking accords required banks to replace rock solid reserves with maths.
Government protected and regulated ratings agencies produced negligent ratings duping pension funds, who were obligated to buy high quality paper, into buying junk cleansed by untested mathematical models.
Central banks create boom-bust.
But most damaging of all was the absurdly low interest rates set between 2001 and 2004.
The resultant glut of cheap money fueled an unsustainable boom encouraging more mortgages to be taken out, and pushing property prices ever higher.
The market responded by pushing scarce economic capital towards highly speculative property development.
As prices rose people remortgaged, and borrowed to consume more. This unchecked process tended to be destructive, as scarce economic capital flowed out of our economy and headed to those economies efficiently producing consumer goods, such as China. Rampant asset inflation clouded our ability to see this depletion process in action.
Everyone had a great time whilst the party lasted, not least Governments who were incentivised to let it run, blinded by ever larger tax revenues.
But all parties come to an end, and central banks had to prick the bubble eventually. Interest rates went too high, and sub prime collapsed, and then all property prices plummeted. Trillions of dollars were ripped out of the financial system, and the credit crunch began.
It’s happened before.
But, despite its complexity, there was nothing new or unpredictable about this process. All the great busts of the 20th century were preceded by a Government sanctioned fiat currency booms.
In the 1920’s, the Fed pursued a ‘constant dollar’ policy. This was the era of the innovation, Model T Fords, radios and rapid technological advancement.
Things should have got cheaper for millions of people, but money supply was boosted to try and keep prices constant. All that extra money flowed into the stock market, pushing prices to crazy levels, and we all know how that ended.
In the modern day, targeting price changes has been an utter disaster for us too.
It let the Bank of England pretend they were doing their job, when money supply was growing at a double digit rate. It let the authorities relax whilst an economy threatening credit bubble was building up.
And it gave Gordon Brown the leeway to convince people that boom and bust was over.
Things should have got cheaper.
Inflation targeting made no allowance for globalisation, the rise of India and China, and the benign falls in general prices that should have been triggered. Think about it; if all those cheap goods were to become available, consumer prices should fall. We would have had greater purchasing power, and become wealthier for it.
But, the Bank of England was aiming at a symmetrical plus 2% target. Falling prices in some goods necessitated stimulating rises in others. They unleashed an avalanche of under priced debt and we had our own crazy asset boom.
Inflation targeting was a myopic policy.
Governments make terrible farmers.
When a central bank sets interest rates, they set the price of credit. Inevitably they create distortions.
Consider this; Governments cannot set food prices without causing a glut -or- painful shortages. Now, food is a pretty simple commodity, yet we all understand that central planners simply cannot gather enough information to set the price accurately.
It has to be left to the spontaneous interaction of thousands of buyers and sellers to set the price.
So, why do we think that enlightened bureaucrats can put an exact price on something as vital, yet complicated, as credit?
In a nutshell, if I can’t tell how much my wife will spend on Bond Street this weekend, how can they?
Let’s wake up from this fantasy.
There is a better way.
What’s the cure? Let the invisible hand to do its time honoured job. Leave interest rates to be set by the millions of suppliers and users of capital.
Get the central planners out of the way.
It’s the way it used to happen. The period of fastest economic growth the world has seen was America between the civil war and the end of the 19th century. Money was free and private and the Fed did not exist.
So, how do we get back to freedom in money? Fredrich Hayek – the great Austrian economist – did the best thinking on this. What he proposed was that private firms should be allowed to produce their own currencies, which would then be free to compete against each other. People would only hold currency that maintained its value, firms that over-issued would go bust Producers of ‘sound’ money would prosper.
History gives us plenty of successful examples of private money working well, 18th Century Scotland had competing banks, all with their own bank notes. People weren’t confused. It worked. There are many other examples.
In the modern age, technology makes the prospect of monetary competition even more tantalising. Mobile phones, oyster cards, smart tags, embedded chips, wireless networks. The internet. Prices could flash up in the shopper’s preferred currency.
A proposal.
Here’s an idea of how to kick the process off;
Tesco’s want to get into banking. Why not currencies as well? Tesco would print one million pieces of paper. Let’s call them Tesco pounds. It would be redeemable at any time for £10 or $15. They would then be auctioned, and the price of a Tesco set.
Anyone who owns a Tesco has a hedge against either the £ OR $ devaluing therefore the Tesco has an additional intrinsic value. Maybe they’ll auction at £12.
Tesco would specify a shopping basket of goods that cost £60. It would promise that 5 Tesco Pounds would always buy that weekly shop. The firm would use its assets to adjust the supply of Tesco Pounds so that they kept this stable value.
They would need to otherwise their shelves would be cleaned out!
As central banks inflated the £ and $ away over time, the convertibility into these currencies would matter less. We would be left with a hard currency that meant something.
There would be other competitors and a real choice about which money to hold your wealth in.
McDonalds has a better credit rating than Her Majesties Government, so maybe people would be happy to hold Big Mac tokens? I don’t know – it will be a free choice.
Currencies would sink or swim depending on how well they performed. What’s more, firms issuing the currencies would come up with different ways of maintaining their value. Some would offer Gold. Manufacturers may use notes backed up by steel, copper and oil.
Let’s see what a free market chooses. Somebody might have a brainwave and come up with an idea that nobody has thought of.
That is what free markets are best at.
I can guess the reactions that my proposal might inspire in some. How would the man on the street cope? Well, nobody would outlaw the Government’s money, and people could carry on as before. Through the operation of the market, we would find out what worked best . Step-by step, the economy would be transformed and standards driven up.
In economics, spontaneous orders are always so much more rational and stable than planned ones. Always.
Conclusion.
This is not a crisis caused by free markets. A free and unregulated market in money has not existed for over a century.
This is a Government crisis. A crisis over the monopoly of money.
Inflation targeting seemed so persuasive…. but it was a false God, and we deserve better. Stability and sound money can only come if we put the money supply back where it belongs…
Under the control of the free market.
By Caitlin Long, on 28 February 11
By kind permission of Morgan Stanley’s Caitlin Long, The Cobden Centre is delighted to publish their report, Inflation Uncertainty and Corporate Finance.
Some key points:
- Inflationary pressures are rising.
- A devaluing US Dollar produces rising commodity prices and devaluing pegged currencies in many emerging markets.
- The pendulum could swing back to deflation again.
- MIT’s Billion Prices Project shows US prices running at over 10% annualised.
- Commodity prices are at all-time highs.
- Food prices are key to inflation in emerging markets.
You can download the report here.
By James Tyler, on 18 February 11
Another classic article from James Tyler, brought forward
Trader: One whose business is trade or commerce.
Trade and commerce is the lifeblood of wealth creation. Without specialisation and exchange, we would all starve. You have oranges, I have apples. Individually we are bored, together we have a fruit salad.
For specialisation, exchange and commerce to work its magic, firstly we need some common ground: a market. Now, mention that word to a Socialist, and he starts to froth and foam at the mouth. The evil of markets, how the market forces this and exploits that, blah blah.
Unfortunately, they are confused. You see a market is just a bit of space, physical or virtual, where people who want to buy meet those willing to sell. That’s it. It has no power of its own. No influence. No horns and a pointy tail.
However, badly aimed as their invective is, they do have a fair grievance lurking in those passionately beating breasts. What they are trying to say is that they object to those who have power in a market. Who wields the power in a market, and where does it come from? That is a fair question to ask.
I contend that power always comes, ultimately, from Government. They hold the monopoly on power, they set the rules, and their arbitrary decisions can mean life or death for any businessman taking a risk. They get the keys to the gun cabinet.
Markets and traders
Only loons attack commerce between good old wholesome types looking to exchange the hard earned fruits of their labour for other stuff they need: I exchange my apples for your oranges.
Unless, that is, you want pears. The free interaction of people that is the market decided on a clever mechanism to get around this problem. It created an intermediate commodity called money.
Money is just a commodity like any other. The free market chose something that was durable, portable, respected, and consistent. The free market originally chose gold and silver as money, and gold remained money until governments came along and nationalised then destroyed it. Money now is a fraud – the greater fool theory of acceptance only because somebody else will too.
The creation of money was a fantastic innovation – a neat solution to the problem of the double coincidence of wants… or rather what to do when there wasn’t a coincidence.
But what happens if an orange farmer wants to sell next year’s crop now? Maybe there is a great demand for oranges and the farmer has cultivated trees to meet the demand, but does not want to take the risk of a craze for plums depressing the demand for oranges. A consumer of oranges may only want to buy what he can pick up and select. A grocer may not want to tie up his cash in something so far off into the future.
What is needed is someone in the middle. Someone willing to guarantee a price for those oranges now, take them in the future and then sell them on when they are needed. This is where the speculator steps in and provides a vital service.
Ahh… the evil speculator, now there is a ripe target!
How can somebody who produces nothing, does not employ physical labour, and does not reorganise the factors of production, be in any way productive in society? Off with their heads!
Speculator: one who speculates on abstruse or uncertain matters
The key is uncertainty. The future is not known; if it was, then the central planners might stand a better chance. But the future peculiarities of individual desires and wants can never be known, so there are always highly uncertain outcomes inherent in planning for the future. The world is too complicated to simplify into maths or bureaucratic diktats. The risks are too great and the mistakes too expensive. What we need is a mechanism to attempt to put a price on future outcomes. We need to “crowd-source” the answer to the problem of resource allocation. And, that’s what speculation is…
I risk my own shirt to take on risks that others do not want. I’m proud to say I speculate. I speculate that I will be able to find another buyer for those risks at a future point in time, and then I charge a fee for my services.
Some say that this is making money from nothing, but I say I provide a service to the world in smoothing out the jagged pointy edges. If things go wrong, I will have to pay the price personally.
The act of speculation is important in the signals it sends out. If prices rise, it signals a shortage which stimulates extra production to satiate demand. Or if the speculator successfully sells short some shares, the falling price will send out a signal that not all is well with that company.
Let me quickly clear a couple of things up …
Markets are not efficient
This is a stupid, indefensible idea peddled by neo-classicist eggheads. Information is often wrong and therefore people err. Mistakes are made, but I contend that the mistakes made by crowds are much smaller than when Government gets its grubby hands on a ‘problem’.
Markets work in waves and ripples and patterns, not aggregates, averages and efficiencies
Early adopters get rewarded the most; late arrivers are penalised. The crowd sometimes gets carried away, and prices rise too much or fall in an unwarranted way, but by and large, when not unduly influenced by power, markets are a remarkably efficient way of making a myriad mind-numbing decisions that all hang together. Markets are smart in the way a regulator can never be.
Short Sellers
Secondly, I want to sing the praises of those great unsung heroes of stock markets: the short sellers.
Selling short is the process of selling something you do not own, in order to profit from a fall in prices, then buying it back at a lower price.
Short selling is a dangerous game. You are hated by all and sundry. Governments, regulators, corporate bosses, and fat cats. Everyone, it seems. You are always at risk of being targeted for a ‘short squeeze’. But short selling is vital for two reasons:
1) Buyers need a seller to buy from.
If you want to buy some shares – who do you think it is that will sell them to you?
It’s not usually an investment fund, or a pensioner, or your mate. It’s the ‘market’, and it is more than likely that the person you bought them from will not own them, but will scrabble around for the rest of the day trying to find them a penny cheaper. Can you be bothered to do that?
The stupidity of banning short selling is that it stops the market working – meaning that movements are likely to be bigger, and the falls greater.
2) Short sellers are the policemen of the markets – a much better (and more fearsome) regulator than the FSA.
Without short sellers, Enron and WorldCom would have got away with their fraud for a lot longer. It is a tragedy that the short sellers of banks were not bigger and better armed during the run up to the sub-prime crisis.
Don’t get me wrong, short sellers were there, playing their lonely game, but they were just too small in face of the great money/banking juggernaut carelessly careening away. Stronger short selling might have seen off the sub-prime fiasco earlier and with less pain.
As a society, we should desperately be encouraging short sellers in situations like this. Big business needs to respect the short seller – it keeps them honest. When prices are rising in a rampant fashion, usually no good comes of this. This is when we need the short seller to tame the wild beast.
Speculators do a much better job of sifting through the morass of conflicting signals to fish out the price for the best allocation of resources in a way that Sir Humphrey, sitting in an ivory tower in Whitehall, could only dream about.
So, traders and speculators are vital for a productive and fully-functioning capitalist economy. In a pure and free economy, they are a force for efficiency and part of the crowd-sourced resource allocation system.
But unfortunately, we do not have free markets
The sub-prime fiasco has shown us that markets, especially financial markets, are anything but pure. Markets are distorted by power, and it’s important to turn your swivel gun onto the source of that power….
The one thing you should always know about busts is that you can’t stop the pain at that point: it’s too late, the damage has already been done. The boom may have felt good at the time, but those tequila slammers at 2am always seem like fun. Remember the feeling in the morning. Trying to alleviate the hangover by more of the same is the action of an alcoholic. It’s the boom when assets are wildly misallocated, and that’s where we should focus.
The sub-prime crisis started with government, was promoted by government agencies, and was taken to the dizzying heights of stupidity by a banking system fuelled with masses of cheap money, produced by central banks that panicked after the previous cheap money bubble went pop in 2001.
The bankers perceived an inexhaustible supply of cash that could be lent at a profit to people who had no chance of paying back. The Mexican strawberry picker given a $750,000 loan to buy a house he could never afford to repay. A cleaner running a buy-to-let portfolio of 4 houses, with zero down payment.
What’s the problem with banks, after all, it’s a free world?
Banks are not run by kindly old bespectacled men, carefully lending money to young families to give them their first break. Remember It’s a Wonderful Life with Jimmy Stewart – the friendly banker looking after good ol’ townsfolk? Scrub it from your mind.
Banks are vast hedge funds, with vast trading floors of speculators, all doing “God’s” work, as some idiot once said.
One UK clearing bank has been described as a huge smart hedge fund, with a mediocre provincial bank bolted onto its underside. That’s probably true for all of them.
A few starters on banks:
1) They are licensed by the government. I cannot start up a bank – neither can you, unless you go through the various hoops, fires, and barriers erected in front of you. You need mountains of capital. They make it difficult to join their club.
2) They operate under a specially loosened set of accounting rules.
Normally, companies are required by accounting rules and law to make sure they provide for their liabilities as they fall due. If you order a load of gear on credit, you have to show that you have the ability to pay for it – and pretty rapidly. Companies are expected to make their creditors ‘whole’
Look at the accounts of Vodafone and in their balance sheet they have to provide for ‘current liabilities’ and ‘long term liabilities’, but not so for a bank. Banks get away with a broad ‘liabilities’ section, with no attempt at sorting near term risks from long terms assets. It doesn’t matter whether they owe money tomorrow and are due to cover it in 5 years time.
3) Banks thrive on red tape, loopholes, fuzzy wording and obfuscation
For instance, 75% of people in this country believe that when they place their hard-earned money in a current account, it remains their money. It most emphatically is not. You hand your money over, and you get a promise. Well, I say promise, but the bank goes to great lengths to hide this fact. You are given a statement, which shows your money proudly sitting there, waiting for you – all safe and sound.
Except it’s not.
It is being lent out to Dubai World! Or passed onto the trading floor, and being pushed into Alphabetti Spaghetti Derivative Hooplas, funnelled into their massive casino operation.
Even though you might spend it tomorrow, the bank will not have your money. If you want it, they have to get it from somebody else’s account, or go onto the money markets and borrow it.
4) A bank is an operation designed to make profits from money that is not their own.
When you put your Tesco’s money into a bank, you are investing in a hedge fund, except you don’t get any of the profits. If it all goes wrong, as it did in 2008, then the taxpayer pays for all the losses.
Even in the good times, the taxpayer insures deposits (explicitly or implicitly), leaving the banks free to gamble away. Does this seem like free market capitalism to you?
What is the problem with this, after all, it’s a free world?
Well, it’s not. As I said before, banks operate with privilege and monopoly rights, with taxpayer backing. And we can add a final potion into the mix: incentive and liability
The sub-prime crisis cost Wall Street and the City trillions, or rather it is costing taxpayers that much. If I lose money, I remortgage my house; otherwise I don’t come back.
When Goldman Sachs put all its eggs in the AIG basket, they should have received a bloody nose – at the very least. Yet uncle Sam paid them out 100c on the $ and Goldman scored a slam dunk. God’s work, eh? A miracle indeed.
A trader called Howie Huber recorded the single biggest loss ever at a bank. He cost Morgan Stanley over 10 billion dollars, but he got to keep the 24 million dollar bonus he earned the year before.
Dick Fuld at Lehmans faced some devastatingly hard questions from some horrible congressmen, but retired a very rich man.
It was the taxpayer who paid the price. Private profits and socialised losses – emphatically NOT what I’d call free market competition.
Now I don’t mean that we should round these guys up and shoot them, or even take their bonuses back – they signed contracts, and we respect the rule of law, and contracts. It’s the basis of our freedom and we risk tyranny if we selectively choose to violate these rights.
We have to recognise that bank traders get a free option. You can bet it all on red or black: win, you get a bonus. Lose, you may lose your job – but then probably use your ‘reputation’ to walk into another one.
The system is wrong, and something must be done about it.
In terms of dealing with the crisis we have to understand that damage is done before we are aware of it. In the sub-prime crisis, it was done in those happy days of 110% mortgages, up front discounted rates, and more freshly printed money than you know what to do with. We were killing our economy with cheap money love.
When gravity asserted itself, and the inevitable bust came we faced a simple choice: take the pain, or hide it.
In 1982, 100 Keynesian economists wrote a letter to the times saying that the government’s economic policies were suicide. It’s a bit of a coincidence, then, that that was the exact moment the real economy started to grow. Time and again, history shows us that if we take our medicine early, we get through the illness quicker.
Or we could take the Japanese/Keynesian approach, and hide it with fiscal aggregate kabalah nonsense. And lose twenty years in the process
But banks.. what should we do with them?
Some suggestions:
1. Firstly, banks should not speculate with your beer money – unless you understand this, and you explicitly sign it off.
2. Banks should be audited as strictly and as thoroughly as normal companies are – no favours.
3. Banks should legally have to provide for liabilities as they fall due – as every other company should.
4. Banks should offer accounts that are 100% reserved. That is where your money is kept safe, not used to speculate – and it remains your property.
5. Speculation should be undertaken by hedge funds and specialist trading groups, not by deposit-taking institutions, or by the likes of Barclays, that can borrow money from the Bank of England at 0.5% and walk over to the craps table.
6. Anybody, or company, that offers fiduciary advice should face 100% liability in case it goes wrong.
And most importantly,
7. Any person paid more than a certain amount by a bank, should be liable when things go wrong.
The contract that Dick Fuld signed should have meant he lost his house when he crashed Lehman’s. Howie Huber should now be serving Big Macs. And Lloyd Blankfein should be a little more circumspect when talking rubbish about doing God’s work.
God is watching you mate… be careful.
By James Tyler, on 15 February 11
Forty years ago today, Britain moved to decimal currency. A 1971 penny was worth the equivalent of today’s 10p. In recognition of this dramatic debasement, and its devastating effects, we are bringing forward this classic article, originally published in December 2009.
Mr Smith works hard, plans carefully, and saves what he can, putting his money into a building society. He pays his credit card bills off each month, and tries to overpay his mortgage when he can.
Mr Smith got a 3% pay rise last year – inflation was only 2% – so he felt good about that. But… he doesn’t feel any wealthier.
Year after year, the government had said that the economy was growing strongly, but still, things seemed harder for his family and him. Train ticket prices up again. Heating bills rocketed when the price of oil went up, but never seemed to come down. He swears a loaf of bread and a pint of milk were much cheaper in years gone by.
When he changes his cash for Euros, he realises that his holiday in France is now unbearably expensive. His tax rates didn’t go up, but still, after all his bills were paid, he seemed to have less and less spare cash than he remembers a few years ago.
There are Mr Smiths everywhere. Careful folk, who plan, save for a rainy day and have a sense of personal responsibility.
Smith is the target.
It is Mr Smith who is going to pay for the banking crisis.
His saved wealth will pay the national debt.
His prudence will bail out Gordon Brown’s profligacy.
His forgone holiday will pay the banker’s bonuses.
His careful spending will pay for the vast number of quangos.
His financial planning will bail out the failed NHS computer project, over-budget military programs and ID cards.
His sense of responsibility will end up funding the destruction meted out in Iraq and Afghanistan.
It won’t be the politicians or the bankers who pay for global warming – he will.
He knows he pays tax… but what is hard for him to comprehend is that there is another pernicious process draining his wealth and subverting his hard work towards paying for the misjudgement of others. Whether he likes it or not, he naively pays for the decisions made by the political class.
He has no choice. No option. He was never asked to vote for it. And for the most part, the act of theft is so subtle he doesn’t even know it is happening.
Why does he feel poorer?
Why is it that Mr Smith seemed to miss the ‘boom’, yet is hurting more in the bust? Why doesn’t life get easier for him? What is going on?
Inflation.
As technology produces things more cheaply, Mr Smith should have been able to reap the rewards – except that things don’t get cheaper for him. Society cheats him when the government opens the spigot of new money, washing this value away as the torrent of new money chases prices higher beyond his reach.
The winners are always those close to the gusher – the banks, financiers and politicians. These are the ones who get to spend the new money first, thus chase prices up before Mr Smith gets any sniff of what is happening.
To save or to invest?
Think about your personal circumstances. Every time your payslip comes in, you have a choice of how much to spend and how much to save. Every rational person knows that there is a balance to be struck between current enjoyment (consumption) and future enjoyment (savings – or deferred consumption).
This choice is exactly the same for society as a whole. As a country, we must decide how much to consume, and how much to defer consumption in order to allow our children and us to enjoy things in the future.
The choice for us all is simple. Defer consumption and invest for the future, or consume and enjoy now.
What is the process by which we save for the future? There are two ways.
- Voluntary saving. If society needs to invest for the future, but people prefer to consume, then the savings rate – the profits paid on investments and/or the interest rate paid on deposits, rises until people choose to defer consumption and invest.
- Forced saving. Government policy forces a decrease of the purchasing power of money via inflation of the money supply. The net effect is a transference of wealth from savers and fixed income groups towards net borrowers (itself included). It also creates an artificial pool of liquidity into which the government can sell its IOUs.
The evil of Forced Saving
The natural state of affairs in a free market, with a more consistent supply of money, is that general prices fall as technology advances. The prudent are rewarded, and borrowers have to carefully evaluate and moderate their flights of fancy, only investing borrowed funds carefully in sound projects.
When the value of money declines, savers find that their money buys less, whilst borrowers are happy to find that they can repay their debts with money of a decreased value. It’s like borrowing five books from the library and finding that you are only required to give four back!
By setting a target for rising prices and then pulling levers to increase the supply of money in the economy to achieve it, the government prevents the natural response of general prices to competition, increased efficiency and innovation: they stop prices from falling.
Entrepreneurs, innovators, inventors and new businesses exist because they believe that they can satisfy society’s wants better than they have been served before. They have ideas, innovations and take risks in order to provide goods that are cheaper than they otherwise would be. Businesses operating in a competitive environment always seek to reduce costs, be that one step more efficient and produce a cheaper or better widget. As group of people, entrepreneurs bring efficiency and innovation, and they make stuff cheaper.
The benefit to Mr Smith should be that his income goes further. As time progresses, technological innovation should mean he can buy more with the same cash. But that’s not what happens, as any pensioner knows. Saved money buys far less now than it did at the time it was saved.
Governments achieve rising prices by encouraging the supply of new money. This new money comes from the central bank via its control of the banking system. The first users of this new money are invariably politicians, finance capitalism and big business. These guys get to use the newly minted money first, and thus spend it first. This process bids up prices, leaving everyone else chasing behind, and poor old Mr Smith last in the queue.
What an evil system it is then, when government can control money in such a way as to give it a first user advantage that penalises all those in the general population whose wealth is being rapidly diluted. A process that systematically violates and loots pensions, savings, fixed incomes and the actions of prudent, and rewards the profligate, the speculative borrowers and above all, rewards the biggest borrower of all: Government.
Let’s be clear. The current system is a process that diverts the benefits of innovation and technological advancement that should accrue to the general population, and thrusts it towards the desired spending of the well connected and the political class.
We need to stop this continual violation of the little man. Mr Smith has to start realising what is happening to him.
That’s why I’m proud to support the efforts of the Cobden Centre.
|
|
