Keynes and Copernicus: the debasement of money overthrows the social order and governments

The United States Senate moves toward the confirmation of Janet Yellen, now posited for next January 6th, as chair of the Federal Reserve System. Let us in this moment of recess reflect on eerily similar observations by two of history’s most transformational figures:  John Maynard Keynes and Nicolas Copernicus.

One of Keynes’s most often-cited observations, from his 1919 The Economic Consequences of the Peace, chapter VI, contains an indictment of policies very like those which the Federal Reserve System has been implementing for the past dozen, and more, years.  These policies in slow motion are, in the opinion of this columnist, at the root of  the very political, social, and cultural dysphoria — uneasiness or generalized dissatisfaction — predicted by Keynes:

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become ‘profiteers,’ who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

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

An almost identical point was made almost four centuries before Keynes by iconic savant and polymath Nicolas Copernicus.

Copernicus commenced a study composed for the Prussian and Polish governments around 1525, On the Minting of Money, with these words:

ALTHOUGH THERE ARE COUNTLESS MALADIES that are forever causing the decline of kingdoms, princedoms, and republics, the following four (in my judgment) are the most serious: civil discord, a high death rate, sterility of the soil, and the debasement of coinage. The first three are so obvious that everybody recognizes the damage they cause; but the fourth one, which has to do with money, is noticed by only a few very thoughtful people, since it does not operate all at once and at a single blow, but gradually overthrows governments, and in a hidden, insidious way.

This does not imply plagiarism by Keynes.  The coincidence between Keynes’s “[To debauch the currency] engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose” and Copernicus’s “[The debasement of coinage] … is noticed by only a few very thoughtful people, since it does not operate all at once and at a single blow, but gradually overthrows governments, and in a hidden, insidious way” is, however, striking.

Keynes, like Copernicus a paradigm-shifter, was himself extraordinarily erudite.  It is not impossible the young Keynes came across Copernicus’s work (which reportedly was first actually published in 1826).   The question as to whether Copernicus’s Essay may have inspired Keynes’s observation must be left to authentic scholars such as Lord Skidelsky.

The similarity may be merely that of “great minds working alike.”  This columnist has found but one direct reference by Keynes to Copernicus.

Keynes (whose thinking was mostly, although not exclusively, opposed to the gold standard) was fascinated by one of Copernicus’s most accomplished scientific successors, Sir Isaac Newton.  Newton, also, achieved iconic status, both for his contributions to physics and, as Master of the Mint of Great Britain, as the architect of the modern classical gold standard. Newton’s gold standard was designed along Copernican principles of close correlation toward nominal and intrinsic value.  It served the world very well for almost 200 years.

Keynes was to have addressed the Royal Society of London’s gathering to celebrate the tercentenary of Newton’s birth, an event delayed by the war.  Keynes died a few months before he could present his remarks.  Maynard’s remarks, Newton, the Man, were presented by his brother Geoffrey (and thus might even be characterized as Keynes’s last words).  A brief excerpt:

Why do I call [Newton] a magician? Because he looked on the whole universe and all that is in it as a riddle, as a secret which could be read by applying pure thought to certain evidence, certain mystic clues which God had laid about the world to allow a sort of philosopher’s treasure hunt to the esoteric brotherhood.

[H]e became one of the greatest and most efficient of our civil servants. He was a very successful investor of funds, surmounting the crisis of the South Sea Bubble, and died a rich man. He possessed in exceptional degree almost every kind of intellectual aptitude – lawyer, historian, theologian, not less than mathematician, physicist, astronomer.

As one broods over these queer collections [of Newton's alchemical writings, which Keynes collected], it seems easier to understand – with an understanding which is not, I hope, distorted in the other direction – this strange spirit, who was tempted by the Devil to believe at the time when within these walls he was solving so much, that he could reach all the secrets of God and Nature by the pure power of mind Copernicus and Faustus in one.

As for Copernicus, On the Minting of Money has been translated into English several times yet those translations remained difficult to obtain for students of the monetary arts and sciences.  It has remained mostly the property of elite historians.  Scant and intriguing references were limited to all-too-brief articles such as “Treatise On the Minting of Coin and Copernicus views on economics” by Leszek Zygner of  Nicolaus Copernicus University.

The full text of Copernicus’s fascinating and invaluable essay remained elusive, that is, until last month.

Laissez Faire Books published a meticulous and fresh English translation from the Latin, with prefatory remarks, bibliography, and invaluable critical apparatus by classicist Prof. Gerald Malsbary. (The volume was co-edited by this columnist and by his  fellow columnist Charles Kadlec, with a foreword by Reagan Gold Commissioner Lewis E. Lehrman, whose eponymous Institute this columnist professionally serves).

From Prof. Malsbary’s Prefatory Remarks to Copernicus’s Essay on Money:

NICOLAS COPERNICUS the astronomer embodies the modern scientific ideal: the revolutionary revealer of a new, verifiable scientific theory that shocks our conventional perceptions. However, it is not very widely known, outside of Eastern Europe at least, that Copernicus also spent about twenty years working on economic theory. His treatise On the Minting of Money (Monetae Cudendae Ratio), was first printed in 1826, three hundred years after its composition in 1525–1526. At the time, the semi-autonomous ecclesiastical region between Poland and Prussia where he lived (Varmia) was undergoing a political and economic metamorphosis, and his judgment and expertise (a fruit of the best late Scholastic and Humanist learning) was summoned by the Prussian and Polish governments to help stabilize an inflated currency. Was his insight into monetary matters as revolutionary as his astronomy?

Keynes: “The process [of debauching the currency] engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”  Copernicus: “[The debasement of coinage] … is noticed by only a few very thoughtful people, since it does not operate all at once and at a single blow, but gradually overthrows governments, and in a hidden, insidious way.”

Malsbary: “Was [Copernicus's] insight into monetary matters as revolutionary as his astronomy?” In a word, yes.

Madame Yellen?  Whether one follows Keynes or Copernicus … it is time to return to the principle of meticulous monetary integrity — as exemplified by the classical gold standard — to restore legitimacy both to to the social order and to government.

This article was previously published at


Economics – orthodox and heterodox

In 2008 as The Great Moderation came to an end, Queen Elizabeth II asked Mervyn King “Why did no-one see this coming?” Her Majesty had clearly not read either Irrational Exuberance by recent Nobel laureate Robert Shiller, or Crash Proof by Peter Schiff (probably not a Nobel candidate). If she had she would have realised that, in fact, at least two economists, albeit with very different approaches, did see this coming. There were warnings, but many chose to ignore them. But Her Majesty was on to something, the belief that the crash had caught economists napping became quite widespread.

This dissatisfaction with the orthodox macroeconomics practiced by policymakers and taught in universities on both sides of the Atlantic has sparked an increased interest in heterodox economics, such as inspired Manchester University’s Post-Crash Economics Society which declares “The world has changed, the syllabus hasn’t”. There is much to commend this trend – much orthodox macroeconomics is mathematically overelaborate bunk. But what exactly is the orthodox we should be shunning and the heterodox we should be embracing?

According to the Guardian, one of the economists backing the efforts of students like those in Manchester is Cambridge University’s Ha-Joon Chang who says “Students are not even prepared for the commercial world. Few [students] know what is going on in China and how it influences the global economic situation. Even worse, I’ve met American students who have never heard of Keynes.”

Really? I did my economics degree at Birkbeck College between 2007-2011. One of my modules was Macroeconomic Theory and Policy and the course text was 2007’s Macroeconomics by N. Gregory Mankiw and Mark P. Taylor. It contains eleven index entries under ‘Keynes, John Maynard’  (‘consumption function’, ‘economic theory’, ‘gold standard’, ‘inflation’, ‘inflation as taxation’, ‘interest rate determination’, ‘investments’, ‘IS curve’, ‘IS-LM model’, ‘real wages, cyclical behaviour of’, and ‘stock market speculation’) and a further nine under ‘Keynesian Cross’ (‘adjustments’, ‘decrease in taxes’, ‘dwindling in popularity of’, ‘economy in equilibrium’, ‘government purchases’, ‘planned expenditure’, ‘policy shifts and’, and ‘taxes’). In another module, Intermediate Macroeconomics, the course text was 2007’s Macroeconomics by Stephen Williamson. Solidly in the Real Business Cycle tradition even this book contains index references to ‘Keynesian business cycle theory’ (‘labor market in a sticky wage model’), eleven references under ‘Keynesian coordination failure model’,  and one each for ‘Keynesian transmission mechanism for monetary policy’, and ‘Keynesian unemployment’.

Besides, the point of university is that you do much of the study off your own bat. At the end of my first year I had got so fed up reading textbooks telling you what was in The General Theory that I went and read it myself. Quite honestly, it is difficult to believe that Chang actually has met “American students who have never heard of Keynes” and if he did they would seem to be uninquisitive, unrepresentative idiots who a change of syllabus is unlikely to help.

In another Guardian article Mahim Husnain and Rikin Parekh of the Manchester society write that “in the education we receive as economics students, there is little stress on how a market could fail”. If this is true then the curriculum at Manchester University is very different to mine. In a module on Intermediate Microeconomics  one of the textbooks we used was 2003’s Microeconomics by Robert S. Pindyck and Daniel L. Rubinfeld, the fourth and final part of which was called ‘Information, Market Failure, and the role of the Government’. We also used Hal R. Varian’s 2006 text Intermediate Microeconomics which included entire chapters on supposed sources of market failure such as ‘Monopoly’ and ‘Oligopoly’, ‘Public Goods’, ‘Externalities’, and ‘Asymmetric Information’.

Much of the microeconomics taught at universities is, in fact, based on notions of market failure and what the government can apparently do to remedy them, so much so in fact, that Joseph Stiglitz, George Akerlof, and Michael Spence won the Nobel prize in 2001 for their work on the subject. If you haven’t come across it either your university is letting you down or you’re not paying attention in class.

Michael Joffe, professor of economics at Imperial College, London, says “many reformers (have) called for economics courses to embrace the teachings of Marx and Keynes”. But heterodox economics should not simply mean any old rubbish. Some of it, like Marx with the ludicrous Labour Theory of Value as the keystone of his system, is heterodox for a very good reason.  And the idea that Keynes is or was particularly neglected and that universities are teaching that markets can never fail is simply untrue; he is an integral part of the orthodox mainstream.

Economists should always be testing their theories against new ideas and to that extent the recent interest in different approaches is to be welcomed. But we should be wary of people trying to pass off the useless (Marx) or the thoroughly familiar (Keynes) as something fresh and challenging.



An article by Cobden Centre fellow David Howden for

Today many of us are wearing a poppy on our lapels in a show of remembrance. What exactly are we remembering?

The Great War from 1914-18 saw many changes to the world. Many of them were bad, though as we shall see some good did come from one of, if not the worst war of all time.

Over 64,000 Canadians lost their lives fighting in Europe, almost 1% of her population. A further 150,000 were injured. The comparable statistics today, updated for population growth, would be nearly 315,000 dead soldiers and almost 700,000 wounded. Remember that these are just Canadian soldiers. The final global death toll was 17 million (including the civilian deaths in the neutral countries of Scandinavia) and over 21 million wounded.

In fact, in this regard one could argue that Canadians came away relatively unscathed. Romania lost 10% of its population, Serbia 16%, and the great Ottoman Empire almost 14%. This latter figure excludes the additional 100,000 Turks who died fighting the subsequent Turkish War of Independence following the signing of the Armistice in 1918.

The First World War was not only the first war to be waged on a truly global scale, it was the first to inflict the magnitude of destruction it did. Soldiers of previous battles were felled by disease more often than in direct combat. Advances in technology changed that, and even though the 1918 outbreak of Spanish influenza killed many more (current estimates place the deaths from the flu at 50-100 million), the Great War killed more people in four short years than most of the previous European wars combined.

In remembering the Great War it is easy to focus on the deaths of those who sacrificed their lives, but it is also important to reflect on what caused the War and what it achieved.

It’s true that advances in modern warfare and logistics made the War able to be fought on a wider scale than ever before. It is also true that a series of alliances – both formal and informal – agreed upon prior to the War brought belligerents into the melee with only tangential interest in it. Canada’s allegiance to Great Britain at the time might be thought of in this way, as could any number of the other Dominions and Colonies including Australia, India, New Zealand and Newfoundland.

Some simple economics also played an important role. Prior to the War most countries of the world had a monetary system linked to the gold standard. Government deficit spending was curtailed under this system as borrowing would be limited by the extent of a country’s gold reserves. The expression “to have a war chest” has its origins in the necessity of a sovereign to carry a chest of gold to war to pay soldiers. Wars under the gold standard were quite limited affairs, curtailed by the supply of gold available to keep soldiers paid (and motivated).

The War brought with it the breakdown of the gold standard as all belligerents resorted to monetary inflation to finance the growing expenses. This one simple fact goes far in explaining why the scope of the War and the resources driven into it were so great. The lack of a spending anchor under a fiat money regime allowed countries to print money and run deficits in order to finance the increasingly expensive battles, expensive both in money and lives. While governments could print money to paper over the cost of the War, soldiers were much less reproducible. As we shall see, the use of conscription was the counterpart to inflation and allowed the War to continue being waged once volunteers ran out.

The Great War was supposed to be the war to end all wars. Unfortunately the signing of the Treaty of Versailles to officially settle it proved to be the peace to end all peace.

A not well-known 36-year old economist by the name of John Maynard Keynes found fame penning his The Economic Consequences of the Peace in 1919. Keynes had two profound criticisms of the Treaty. First, that Europe could not survive and prosper without an integrated economic system, something that the Treaty precluded. Second, that the Treaty violated many terms of the Armistice signed 95 years ago on the eleventh hour of the eleventh day of the eleventh month of 1918. The armistice included terms relating to war reparations, territorial adjustments and general even-handedness in economic matters.

Keynes presciently predicted that the Treaty of Versailles would be the cause of a future war, and 20 years later he was proven correct. Poor economic conditions in Germany as a result of war reparations and the loss of culturally and economically important territories set in motion a series of events that brought Adolph Hitler to power and resulted in the invasion of Poland by both Fascist Germany and Communist Russia in September 1939.

Six years and 50-85 million additional deaths later the world had a new Great War. This one necessitated a numbering system to distinguish the first Great War from the Second.

All of this death and destruction could easily be pegged on one person. The Bosnian Serb student Gavrilo Princip may have fired the shot that killed the heir to the Austo-Hungarian throne, the young Archduke Franz Ferdinand of Austria on June 28th, 1914. But Princip was not alone in his distaste for the ruling class of that Empire.

Indeed, general unease concerning many sovereigns and governance structures were warming like kindling, ready to ignite Europe at any time. Secession problems in the Austro-Hungarian Empire and brewing revolutions in both the Russian and Ottoman Empires were slowly creating the conditions for civil wars.

The British Empire under the rule of King George V was also going through its own coming of age problems, though nothing severe enough to spark bloody revolution. Indeed, the Great War ushered in an era that saw Britain’s Colonies and Dominions reorganise into a peaceful and voluntary structure. In few places was this push more apparent than in Canada.

A bloody Battle of the Somme resulted in Prime Minster Robert Borden’s pledge to send 500,000 soldiers to Europe by the end of 1916, despite a population in Canada of only 8 million at the time. Conscription was enacted to offset the dwindling supply of volunteers to join the War cause.

Almost all French Canadians opposed conscription, feeling no allegiance or duty to aid either England or France. The Conscription Crisis of 1917 was primarily a backlash of Francophone Canadians against the forced military service imposed by Ottawa to aid his Majesty’s war. Uneasiness about being Catholic soldiers under predominantly Protestant commanding officers also fuelled the flames.

The Conscription Crisis exposed Ottawa to many difficult questions. One problem was that by forcing labour, the Canadian government had no knowledge who would be the best soldier, toolmaker or farmer. Someone had to stay back and supply those who went to fight, but the government lacked any rational way to make this decision. More importantly, there was the apparent rights issue. Canada had never before enacted conscription, and the idea of forcing someone to fight in a war against their wishes is morally repugnant. More to the point, fighting a war in a distant land to aid a government which one never voted for created its own problems. The problem lives on today for pacifists around the globe, as well as those who choose to refrain from political participation.

Indeed, in a bid to garner support for conscription the Military Service Act of January 1st 1918 included exemptions to remove oneself from the forced call of duty. By autumn of that year these exemptions were removed, in a move that offended not only the French but also English-speaking Canadians. This move by Robert Borden not only shut the Conservative Party out of Quebec for over 50 years, but also caused them to lose the next general election in 1921 to the Liberal’s of William Lyon Mackenzie King.

At the very least, the Conscription Crisis put in motion a debate as to what role and duty, if any, the Dominions and their citizens had in regards to the United Kingdom. The culmination of these debates was the Statute of Westminster, signed into law by the Parliament of the United Kingdom in 1931 and passed on to all realms within the Commonwealth for ratification shortly thereafter. Amongst other things, the Statute legislated equality and self-governance for the Dominions that ratified it. (Not all colonies did so: Newfoundland Colony did not ratify the Statute, and remained a Dominion of the British Empire until joining Canada in 1949.)

The Commonwealth of Nations today survives as an organisation of 53 countries, most of which were territories of the British Empire. It represents a quarter of the world’s land mass, almost a third of its population and 15% of the globe’s GDP. It is a voluntary group which exists due to some loosely shared values paired with some established statutes.

Racial equality is a requirement for inclusion, and this was tested with the withdrawal of South Africa under apartheid, as well as its eventual readmission after its end. Not all member states recognise the Queen as the head of State, though some (like Canada) do. We have a shared history, heritage and traditions (like wearing a poppy on Remembrance Day). Chief among these is obedience to the common law, one of the greatest forces of civilisation in history. A dedication to peace, liberty and free trade are all points for inclusion, secured by the values of the 1971 Singapore Declaration.

There are no formal laws dictating that member countries must trade or associate with one another, but they do. The voluntary nature of this institution is apparent in the immigrants that flow between Commonwealth nations as well as the fact that Commonwealth members trade up to 50% more with other Commonwealth members than with non-members.

Inclusion in the Commonwealth does not yet instil by law the free movement of goods, people or money across borders, but it would be wise to do so. Some countries give preferential treatment to immigrants or investors from other Commonwealth countries, and the benefits are clear. Economic prosperity reigns when people, goods and money go to where they are treated best. Informal preferences within the Commonwealth promote this.

There is discussion of making the Commonwealth into a broader free trade union, as is the case with the European Union. This should be welcomed as it would solidify into law those benefits which heretofore are only informally recognised.

A word of caution is in order.  Should the Commonwealth choose to formalise its union it must do so in its own way and according to its founding principles. Liberty and freedom are among these, and the voluntary nature of the union must also be upheld. (This in distinction to the mandatory nature of the European Union which now results in ill feelings of coercion or otherwise being forced to behave in ways undesired by many citizens of the member states.) Infringements to freedom and liberty, such as those occurring in South Africa under apartheid must be met swiftly and surely with exclusion from the union.

United we stand, but only if you want. Countries can choose to break the rules that have promoted peace and prosperity for so long, but must do so of their own accord and separately of Commonwealth benefits.

There is historical precedent for this. South Africa was forced to withdraw from the Commonwealth in 1961 under growing opposition from other members to legislated discrimination based on race. The Commonwealth reopened its arms at the fall of apartheid, and South Africa was readmitted in 1994 (less than one year after the fall of apartheid).  More recently Zimbabwe was suspended for its human rights violations, ignoring the rule of law and suspension of its constitution, and the country’s government decided to formally withdraw in 2003.

Zimbabwe – when your government gets its act together and restores the conditions for peace and prosperity so cherished by the rest of us we will be waiting with open arms.

The Commonwealth has no positive obligation to set straight those countries that pursue different policies than us; who are we to decide? But not playing by our rules will not be tolerated and will be costly for belligerent countries. This is established by the final article of the Singapore Declaration, which states:

These relationships we intend to foster and extend, for we believe that our multi-national association can expand human understanding and understanding among nations, assist in the elimination of discrimination based on differences of race, colour or creed, maintain and strengthen personal liberty, contribute to the enrichment of life for all, and provide a powerful influence for peace among nations.

Coercion is rejected as a policy tool to enforce these values. Even though the Millbrook Commonwealth Action Programme does set out that Commonwealth Nations must concern themselves with other members’ internal situations, it limits repercussions to sanctions, suspensions and expulsions from the group as punishments for persistent violations to its core values.

The continued voluntary nature of the Commonwealth sets it apart from other groups, such as the European Union, and goes far in explaining why this very large and diverse grouping of countries has stood together for almost 65 years. Countries have been free to leave in that period as well as apply for admission, but the core values shared by these member states – freedom and liberty – have not been altered. We are the better for it.

And so today we remember, not just the evils and injustices of 95 years ago but of the benefits that we have today as a result. The freedom and liberty that Canadians enjoy are in no small part the result of the injustices suffered during the Great War.

Canada’s Conscription Crisis in particular was a critical albeit costly coming of age moment. The Statute of Westminster that it resulted in freed Canada and the other Dominions from forced service to a Crown it never voted for. In its place was formed a voluntary Commonwealth of Nations, joined by certain principles and rights but not irrevocably so. Countries can choose to not adhere to these principles, but the Commonwealth will have nothing to do with them if they choose this path. Despite being a stalemate for many years the Great War did accomplish much. The formation of the voluntary union of the Commonwealth might not have been so without it.

And for this, in addition to the thoughts of those who perished and their families, we remember.


Et in Arcadia ego

Continued from Been there, done that, bought the T-shirt

Having broadly tried to demonstrate where we differ from our rivals and where we find their tenets most objectionable, you might be hoping that I will now be tempted to go into the details of what an Austrian might recommend by way of a remedy for our current ills even though this would exhibit a clear infraction of Hayek’s admonition that ‘the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design’!

So, rather than having me succumb to such a ‘fatal conceit’, let me instead sketch the outlines of what would, in an Austrian estimation, be a world in which we would be unlikely to repeat our present stupidities, certainly not on the Olympian scale on which we currently practise them.

Firstly, we should recognise that much of our success as a species comes from our adherence to that peculiar form of competitive co-operation which we Austrians term ‘catallactics’ – i.e., the business of exchange, of trading the fruits of our varying endowments, aptitudes, and accomplishments to the mutual benefit of both counterparties to what may well be a single-priced transaction but which is nonetheless never a zero-sum one (at least when it is undertaken voluntarily and in good faith).

As a direct consequence of this, we can assert in the strongest possible terms that we therefore tamper with the means by which we conduct such dealings – we meddle with our medium of exchange, our money – only at our peril. To us, dishonest money is the root of all evil, not ‘shadow banks’, ‘moral hazard’, ‘regulatory capture’ or any of the manifold offshoots of human cupidity in general, for the ability of such perennial failings to wreak widespread havoc in either financial markets or economies, per se, would be much more severely limited if money were not so easily corrupted alongside the men who use it.

A good deal of discussion has taken place at this gathering and many ideas have been thrown up  – many of them earnest, most of them shrewd, some of them even practicable – as to how to improve our present modus operandi. But unless banking and finance better reflect economic reality – and by this I mean of course Austrian reality! – all of them will be in vain: not so much shuffling the deckchairs on the Titanic as pruning the vines growing on the slopes of Mt Vesuvius, perhaps.

It should be further recognised that a vital subset of our economic interactions consists of that swap of jam today for jam, not just tomorrow, but for a long succession of tomorrows that we might more grandly term ‘intertemporal’ exchange. Indeed, it can be argued that this process is even more intrinsic to our humanity: that the move away from such hand-to-mouth activities as scavenging, foraging, and predation and towards the rational provision for the future by means of forward planning is very much what put the sapiens into the Homo, way back when Also sprach Zarathustra was first ringing out as the soundtrack to Mankind’s great Odyssey from the campfire to the Computer Age.

It is in this devotion of forethought and its associated deferral of immediate gratification where the concept of ‘capital’ first comes into our story and while this opens up before us a vista of riches bounded only by the interplay of our imagination and our willingness to make a short-term sacrifice in order to gain a longer term advantage, it is intrinsically fraught not only with estimable risk, but with unknowable uncertainty, as well as being subject to the further proviso that our own actions’ influence may well serve to increase the range of possible outcomes far beyond what we had first thought likely.

Keynes himself waxed lyrical about the ‘dark forces of time and ignorance’ – even if his own teachings have done more than most over the intervening years to enhance the occultation and obscurity against which his fellow men would have to contend – so it should not come as a surprise when we next insist that none of our man-made institutions can be said to be well-crafted if they aggravate these difficulties.

Economic institutions should thus allow information to percolate in as uncorrupted a manner as possible and should allow for feedback signals to be generated in as direct and unequivocal a fashion as they can. These should clearly flag where both success and failure has occurred so that useful adaptations can proliferate while the ineffective ones are abandoned as rapidly as can be. In essence this means that we must not pervert prices and, since every price is necessarily a money price, the unavoidable inference is that we should not mess with money.

A corollary to this is that there should be the least possible impediment to any and all such adaptations being attempted; indeed, much Austrian ink was spilled during that dark decade of the 1930s in arguing that the surest remedy for the many ills then afflicting the West was to sweep away the obstacles to change and to lubricate the working of the machinery – to practice a policy of Auflockerung, in the phrase of the day.

Following on from this, it should be evident that property should be inviolate and the wider rules of contract should be both transparent and consistent in their application. The law should be concerned principally with equity, the courts with providing a cost-effective and disinterested forum for the arbitration disputes arising from any violations of the first and of any failure to fulfil commitments freely made under the second. Aside from the many ethical considerations attaching to such a demand, we would argue for it additionally in terms of the need to reduce all the uncertainties under which men must act to their achievable minimum if we are to encourage the widest degree of peaceful association, the richest web of commercial relations, and the greatest degree of capital formation that we can.

What we do not want is to be inflicted with a shifting snowball of often retro-active regulation. We must avoid a diffusion or supersession of individual responsibility and desist from fuzzy, catch-all law-making – in fact, we should tolerate as little legal positivism as possible, especially of the kind enacted, often cynically, during periods of crisis. We must insist that the state offers neither explicit nor implicit guarantees, that no bail-outs, or back-door favours be extended to the privileged few at the expense of the disenfranchised many. Finally, it should be impressed upon our elective rulers that the politics of disallowing loss, however well-intentioned, is nothing more than a policy of disavowing gain.

Though there are wider ramifications, the worlds of money and finance should, of course, be subject to all the above strictures. Here, we would again emphasize that to interfere wilfully with the substance of our money is to put oneself in breach of most of these guidelines; indeed, that this is perhaps the most heinous of all infractions, since it entails the most pervasive attack upon both property and the sanctity of contract that there can be since it involves a post hoc and highly arbitrary change in the dimensions of the very yardstick by which the terms of all such agreements are drawn up.

We would further contend that the paving stones on our road to the future, on the intertemporal highway whose praises we have already sung, are nothing more than our investments. These should be funded with scarce savings, not financed by the paltry fiction of banking book entries and hence the business of investment should be conducted only in accordance with the balance we can jointly negotiate between our current ends and our ends to come; that is, on a schedule which naturally emerges to reflect our societal degree of time preference and which does not emanate solely from the esoteric lucubrations of some central banking Oz.

Progress may be less spectacular this way, unpunctuated as it will be by the violent outbreaks of first mass delusion and later disillusion which comprise the alternations of Boom and Bust. But it will be, by that same measure, steadier and more self-sustaining. Absent such a condition, the fear I have already raised is that all the well-meaning calls for better financial regulation and more condign penalties for banking malfeasance are so many straws in the wind as far as a better functioning financial apparatus is concerned.

In passing, the very fact that we are all gathered here to bring so much effort and expertise to bear on the problems thrown up by our contemporary methods of finance shows just how far we have strayed from a true appreciation of its abiding scope as what is effectively little more than a glorified, if somewhat disembodied, form of logistics. Finance should be a record of the assignment of goods and property rights across time and space – a four-dimensional bill of lading, as it were. It would be better were it seen for what it is – a means and not an end; the flickering reflection of a deeper Reality on the wall of Plato’s cave, not a towering 3D IMAX rendition of a screenwriter’s imagining. It should once again be valued only as the carthorse and not as the cargo he pulls behind him.

This article is the fourth in a series. The final instalment will follow shortly.


The bankruptcy of governments

The following is a transcript of the “Adam Smith Lecture” I gave at a private gathering in London on 19 February.

For a long time governments have been redistributing peoples’ income and wealth in the name of fairness. They provide for the unemployed, the sick, and the elderly. The state provides. You can depend on the state. The result is nearly everyone in all advanced countries now depends on the state.

Unfortunately citizens are running out of accessible wealth. Having run out of our money, Governments are now themselves insolvent. They started printing money in a misguided attempt to manage our affairs for us and now have to print it just to survive. The final and inevitable outcome will be all major paper currencies will become worthless.

To appreciate the scale of these problems, we must understand the errors in economic and monetary policies. I shall start with economics.


Modern economists retreat into two comfort zones: empirical evidence and mathematics. They claim that because something has happened before, it will happen again. The weakness in this approach is to substitute precedence for the vagaries of human nature. We can never be sure of cause and effect. Human action is after all subjective and therefore inherently unpredictable.

The mathematicians like to think that economics is a physical science and is not a slippery social science. Economics is a branch of human psychology. It is plainly nonsensical to apply maths to human psychology.

The result is that much of the good work done by the classical economists like Adam Smith has been destroyed by modern economics. The classical economists explained the benefits of doing away with tariffs and the guilds. This revelation was instrumental to the industrial revolution. Then along came Marx who persuaded people that economics was a class interest, that free market economists were promoting the interests of the bourgeois businessman to the disadvantage of the worker. That became the justification for communism and socialism. Keynes and those that followed him never properly challenged Marxian fallacies. They were never involved in what became known as the socialist calculation debate.

It is not generally appreciated that Keynes was strongly socialistic. In the concluding remarks to his General Theory, Keynes looks forward to the euthanasia of the rentier (or saver) and that the State will eventually supply the resources for capital investment. He wanted the state to control profits.

Keynes was primarily a mathematician. Keynes was no more an economist than Karl Marx, whose beliefs led to the economic destruction of Russia and China; or John Law, who bankrupted France, with similar fallacies to those of Keynes.

The misconceptions of Keynesianism are so many that the great Austrian economist von Mises said that the only true statement to come out of the neo-British Cambridge school was “in the long run we are all dead”.

Let me define economics for you at the simplest level. We divide our labour. Each one of us is a consumer; an entrepreneur whether for wages or profit; and a saver for the future. We invest savings to improve production. Each of us discharges these three functions in the proportions we choose as individuals, we interact with others doing the same thing. We exchange our goods at mutually agreed prices using money to facilitate the exchange. We use money to keep score, and that money has to be sound for our calculations to mean anything. Together we are society itself, each providing things others want and will pay for.

The state has no role in this process. Instead it is a cost to society, because it takes some of our spending and savings to support itself. The more the state takes the greater the burden. It destroys society’s potential wealth. But it has not stopped there. Socialism forces the vast majority of people to give up saving and rely on the state to provide. Governments everywhere are now encumbered with obligations they cannot possibly discharge.


On the money side our mistakes go back to the Bank Charter Act of 1844.

The Bank Charter Act gave the Bank of England a note-issuing monopoly backed by gold and government debt. It failed to stop other banks issuing bank credit. This led to credit-driven business cycles which were socially destabilising, adding fuel to the various brands of communism and socialism that developed in the late nineteenth century.

Gold backing for the Bank of England’s notes was gradually eroded, starting in the late 1890s, with a number of countries, including Britain, abandoning it altogether in the interwar years. A gold-exchange standard was adopted for central banks at Bretton Woods. And finally President Nixon in August 1971 abandoned gold altogether.

Ever since then, the expansion of money supply has been increasing exponentially. Quantitative easing is now required to keep the pace of printing up, lest interest rates begin to rise.

Monetary policy from the 1920s has been used to manage an increasingly unstable global economy. The irony is that this instability has its origins in the expansion of money and credit itself. The growth of money supply and bank credit has as its counterpart debt. Few are the assets not encumbered with this debt. Asset prices need more money and credit to sustain them. It is a finite process that ended with the credit crunch five years ago.

That is the background. Now I shall look at the situation today, five years on from the credit crunch. There are four interlinked problems that cannot be resolved: the economy, the banks, government finances and population demographics.

The economy

The advanced economies have been progressively undermined by government intervention and unsound money. They are taxed and regulated to such a degree that laissez-faire hardly exists anymore.

Government spending typically amounts to 50% of GDP in the advanced economies; sometimes more, sometimes less. For productive businesses it is like running a marathon carrying a bureaucrat on your back who tells you how to run.

The misallocation of economic resources which is the result of decades of increasing government intervention cannot go on indefinitely. Businesses have stopped investing, which is why big business’s cash reserves are so high. Money is no longer being invested in production; it is going into asset bubbles. Dot-coms, residential property, and now on the back of zero interest rates government bonds and equities. These booms have hidden the underlying malaise. There can be no economic recovery. Our bureaucrat-carrying marathon runner is finally collapsing under his burden.

The burden of government is now too great to be sustained.


Banks are geared 25 to 30 times, which is fine if you can grow your way out of problems. That is no longer the case. They are vulnerable to existing but unrecognised bad debts, and now a fall in government bond prices. All that’s needed to trigger a collapse in the banks is absence of economic recovery. If we have a downturn it will be quicker. All that’s needed is a rise in interest rates, to reduce collateral values. All that’s needed is a fall in asset prices.

Then there is the shadow banking system, which the Bank for International Settlements reckoned amounts to over $60 trillion, of which $9 trillion is in the UK. If an investment bank goes under, the shadow banking system could make it virtually impossible to ring-fence the others.

Another area of risk is cross-border exposure. Cross border loans in Europe amount to EUR3.5tr. France is 1.2tr. Italy 700bn. Spain 500bn. These are only the obvious risks. Much of this is cross-border within the eurozone, meaning a default in any of those three is certain to wipe out the European banking system, and then everyone else’s.

For this not to happen requires the central banks to make available unlimited funds in the form of credit and raw money. As Mario Draghi said, whatever it takes. His solution is to print enough fiat currency to save the system.

Government finances.

From the time of the banking crisis, government finances have deteriorated sharply, and their debts rocketed. No country, except some in the Eurozone has managed to cut government spending, and only those which did, did so under extreme financial pressure and because they couldn’t print money. The fact is that everywhere government spending is increasingly mandated into pensions, social services and healthcare, which makes spending cuts extremely difficult.

Until recently it was assumed that economic recovery would generate the taxes to balance the books. That has not happened, nor can it happen. In the Eurozone governments are now taking on average over half of every working man’s income and deploying it unproductively. Take France. Government is 57% of GDP. The population is 66m, of which the employed working population is about 25m, 17m in the productive private sector. The taxes collected on 17m pay for the welfare of 66m. The taxes on 17m pay all government’s finances. The private sector is simply over-burdened and is being strangled.

The interest rates at which governments borrow are entirely artificial, made artificial by their own intervention in the debt markets. They are financing themselves by printing money to buy their own debt. The moment this ends, and it will, money will flow out of bonds, equities and even property priced on the back of low interest rates. The pressure for interest rates to rise will have to be met with yet more money printing, because governments cannot afford to pay higher interest rates, nor can they afford to see private sector asset values fall. Price inflation will create a real crisis, perhaps later this year.

Population demographics

Populations in the US, the UK, Japan and Europe are growing older. This is bad news for government finances. When someone retires, he stops paying income taxes and becomes a cost. High unemployment is also costly, because the unemployed are not funding future liabilities. Professor Kotlikoff of Boston University has calculated that in fiscal 2012 the net present value of the US Government’s future liabilities increased $11 trillion to $212tr. The whole US economy is only $15 trillion. Europe is worse, far worse: Europe has more pensioners as a proportion of the working population, high rates of unemployment and a large government relative to the private sector, which funds it all. The UK, taking these factors into account, is slightly worse off than the US. Japan has worse birth rates and longevity. They sell more nappies for the incontinent than they do for new-borns. The solution already is to issue increasing amounts of unsound currency.


The world’s economic problems have been building for a long time. Economic fallacies have been pursued first by Marx and then by Keynes in the 20th century, and monetary policy first took a wrong turn with the Bank Charter Act of 1844. The progressive replacement of sound money by fiat currency has destroyed economic calculation, and has destroyed private sector wealth. These policies were deliberate. We have now run out of accessible wealth to transfer from private individuals to governments. That is our true condition.

Governments will still seek to save themselves at the continuing expense of their citizens, and in the process destroy what wealth is left.

There can only be one outcome: the bankruptcy of governments. This means that their fiat currencies will inevitably lose all their purchasing power.

How soon? I’m afraid sooner than most people think. Japan is already entering the black hole, with her currency beginning its collapse. The UK is on the precipice and cannot afford further falls in sterling without triggering the rise in inflation that will force a rise in interest rates and a spiral into insolvency. Europe could go at any time. The US is probably the best of a very bad bunch, but even her economy is looking bad.

I do not make these statements because I am gloomy. I make them because I approach economics without emotion and without political bias. I make them because I have considered our true economic and monetary position using as far as I am able sound aprioristic theory applied to our current position.

Thank you.

This transcript was previously published at


Masterly inactivity

Before we really get into the detail this week, let us just deal with one simple canard: this idea that if the US Congress does not immediately roll over and allow the Administration to have its head in consuming the capital of the nation at its present, unsustainable rate, the whole house of cards will come crashing down around its members’ ears.

Not least of the reasons for our rejection of this cheap exercise in scaremongering is that the $43 (and not the bruited $85) billion or so which will supposedly be trimmed back in the course of the next fiscal year, should the dreaded ‘Sequester’ actually take place, is no more than the amount of new money the Federal Reserve has pledged to inject into the system each and every month by way of purchases of USTs, for ever and ever, Amen.

It would also be remarkable if the fictional Keynesian ‘multiplier’ – so remarkable in its absence when the government was spending an extra $1 trillion annually with hardly any unequivocally attributable addition to jobs (Solyndra, anyone?) – will now become so magnified in its effects that a trimming of that largesse 1/24 the scale will instantly cause 700, 000 positions to evaporate. Right! What we are being asked to swallow whole is the idea that if government spending slips back by no more than 0.75% of its inordinately large total – a proportion which is actually more like 0.125% of total, economy-wide, annual turnover and which is equivalent to no more than 35-40 cents per head per day – then the Apocalypse will be ushered in forthwith

Well, your author, for one does not believe that the economy – any economy – is THAT fragile. After all, the sum in question is roughly of the order of half the official tally of retail sales of sporting goods. Where Nike goes, there goes America??

Nor is he convinced that the state controls or even monitors its budgets with that degree of accuracy in the first instance. Just think ‘Pentagon’, not to mention ‘black-ops budget’. In that light, $43 billion would be all noise and no signal even it were not a ‘reduction’ in a posited increase rather than an outright cut. Finally, if none of this has assuaged your worries then, by implication, you must believe that we are now locked in to spending over a $1 trillion more than revenues in perpetuity. If so, stop selling your gold, for heaven’s sake, give your assault rifle a quick once-over, and make sure the axle has been greased on your wheelbarrow.

Partly this lack of comprehension is just another example of the strategy of the ‘Big Lie’ as instituted by Bernays, refined by Goebbels, and institutionalized ad nauseam by today’s cradle-to-grave, career-politician spin-doctors. Partly it emanates from the dreadful  pseudo-mathematical juggernaut which is macroeconomics and its intellectually impoverished inability to recognise that its devotees’ cherished time series aggregates are nothing more than a pale, fictional reflection of the joint actions of millions upon millions of disparate individuals, each ceaselessly selecting from their non-ordinal and ever-varying lists of subjective preferences in order to achieve a momentary elevation in their psychic and material condition.

It is bad enough that we routinely forget just how approximate all these numbers are when we apotheosize them to the status of the fundamental laws of nature by which we must ‘govern’ the running of our rigid economic machinery (another pernicious, but all-pervasive metaphor which obscures clear thinking about the functioning of what is really a complex, evolving ecosystem of interpersonal exchange).

But when we then lose sight of the underlying reality itself; when we put effect before cause and come to regard those numbers’ temporal trajectories as an end in themselves, we really begin to do mischief. All anyone can really ask of ’policy’ is that it provide the most conducive institutional conditions under which the average citizen can attempt to satisfy his own unique desires as best he can, and as only he knows how to do. Far from encouraging some Hobbesian, zero-sum hell, such a minarchist approach can only maximise our collective good fortune in that this is something the individual will find extremely hard to effect without contributing something in return to the well-being of the fellows with whom he interacts under a mutually enriching division of labour and subject to a clear and consistent rule of law.

If we, as policymakers, manage to achieve that—or, more realistically, if we refrain from acting in a manner likely to jeopardize it—then, as and when we next take a rough reading of the temperature of all the myriad economic processes currently underway, we may well be pleasantly surprised to see that it is has undergone a modest and entirely wholesome rise. If, however, we construct a spurious mechanics of the nation-at-large and start throwing levers willy-nilly because some statistical fiction or other seems to have had a fleeting numerical correlation with that temperature in the past—and if, moreover, we have already conflated an increase in this one scalar reading into our ultimate end of an improvement of the common weal—even if it should subsequently rise at all, we have no way of knowing whether this is all to the good, or whether this is because the organism is now suffering heatstroke, a fever, or is, indeed, spontaneously self-combusting.

To reiterate; instead of fretting that we have “blundered in the control of a delicate machine”, let us recognise that there is no such construction: that we must not rely on what are essentially static, equilibrium relations between non-existent, top-down concepts to guide our tinkering, but we must learn to deal—and very much at arm’s length!—with a dynamic, non-equilibrium, emergent order, bubbling up from the smallest scale; that what we are dealing with is a process not a pattern—a becoming not a being.

It is therefore not Keynes or Kuznets to whom should be looking, much less the ineffable Krugman, but the shining example of Sir John Cowperthwaite whose enlightened strategy of what he called ‘positive non-interventionism’ in 1960s Hong Kong—coupled with a near blanket ban on the collation of official statistics for fear their provision would tempt men into meddling (“If I let them compute those statistics, they’ll want to use them for planning.’’)—allowed the entrepot to more than quadruple its GDP per capita (it really is a hard habit to break, isn’t it?) in comparison with its colonial masters in dour, socialist Britain, in the space of single generation. 

A man who eschewed tariffs in an era of protection; who abstained from government borrowing at a time when his peers were fast becoming ’all Keynesians now’; who capped income taxes at a modest 15% in an age when the rich were being ‘squeezed until their pips squeaked’; and who resolutely refused all blandishments to shower corporate welfare upon the taipans, Cowperthwaite’s assessment of his own role was nonetheless characteristically modest, once declaring that, as regards his contribution to Hong Kong’s success,

I did very little. All I did was to try to prevent some of the things that might undo it.

Today, when we are plagued with the grossest of governmental interventions, the maddest of monetary manipulations, and the most invidious of attacks on individual wealth, it might serve to reflect upon some of Sir John’s expressed principles. 

On capital controls:

… money comes here and stays here because it can go if it wants to. Try to hedge it around with prohibitions and it would go and we could not stop it and no more would come. 

Re the role of the state vis-à-vis the private sector in production:

…when government gets into a business it tends to make it uneconomic for anyone else.

On what we Austrians would call the great ‘knowledge’ problem—so routinely overlooked by the meddlers in office:

In the long run, the aggregate of decisions of individual businessmen, exercising individual judgment in a free economy, even if often mistaken, is less likely to do harm than the centralized decisions of a government, and certainly the harm is likely to be counteracted faster.

Or this:

For us, a multiplicity of individual decisions by businessmen and industrialists will still, I am convinced, produce a better and wiser result than a single decision by a Government or by a board with its inevitably limited knowledge of the myriad factors involved, and its inflexibility.

And again:

I must confess my distaste for any proposal to use public funds for the support of selected, and thereby, privileged, industrialists, the more particularly if this is to be based on bureaucratic views of what is good and what is bad by way of industrial development. An infant industry, if coddled, tends to remain an infant industry and never grows up or expands. 

Are you listening, Mr Cameron; écoutez-vous, M. Hollande?

 But, setting aside the political philosophy for now, let’s return to the humdrum business of commenting upon that laboratory of central bankers, that Petri dish of those armed with the printing press, that we touchingly refer to as the ‘market’.

Much of the week has been an exercise in Google-translated rune-reading from China’s ongoing ‘Two Meetings’ at which the formal handover of power will be undertaken. Largely monopolized so far by the outgoing crew, we have to wonder whether Wen Jibao’s effusiveness reflects policy as it will be or whether it is simply a wistful, legacy-minded expression of policy as it should have been.

For what it’s worth, there has been plenty of open criticism of the GDP-at-all-costs model and some frank recognition of the scale of the malinvestment already in place. For example, NDRC chairman Zhang Ping candidly admitted that ‘a rising number’ of heavy industries were making losses and ‘lamented’ the overcapacity in steel, aluminium, cement, glass making and coking coal. Plants in these sectors, he said, were running at just 70-75% of capacity, while the once booming solar industry was operating at just 60%. To address their ‘huge difficulties’, Zhang said he was pushing to increase the pace of mergers in these sectors, but also confessed that such an approach has had ‘little success’ in recent years.

The financial flipside to this was made plain by Li Yining, professor at Beijing University, who warned a CPPCC press conference of nothing less than ‘a possible financial collapse caused by over-investment amid the country’s new urbanization wave.’ – you know, the same ’wave’ on which all the CCP’s hopes are being pinned for the coming years. 

In the midst of this, we were treated to the release of the Chinese trade numbers for February which, for reasons of LNY calendar variability, are best combined with those for January when we attempt to gauge the state of play. Intriguingly, imports—not the least imports for number of key commodities, such as copper, iron ore, and oil—were relatively subdued and hence,  in keeping with anaemic showing of neighbouring Korea and Taiwan. But, despite this, exports took a major jump, rising by almost a quarter on the same two months of 2012.

How did that happen? Had China suddenly and dramatically reduced the erstwhile heavy contribution of foreign inputs to its output? Was this a staggered liquidation of product built up in QIV’s hothoused burst of activity? Or was it perhaps an exercise in good, old fashioned, tax and subsidy arbitrage and/or chicanery aimed at evading the current account restrictions?

We ask this because, although they, too, rose in absolute terms, exports bound for the United States—after all, the fastest growing of all the large, net-deficit economies and hence there most likely destination—fell to a modern-era record low share while those to round-trip Hong Kong soared 60% to a new outright and relative share high. At the same time, the country saw record foreign exchange inflows of more than $100 billion—a marked contrast to last year’s hefty drain of hot money. Not coincidentally, this was a period in which the traditional speculative vehicles, the markets for stock and property, both, were on a violent upward tear.

So, were exports—possibly greatly overinvoiced—again being used to wash funds through the somewhat porous capital account barrier, picking up tax rebates along the way? Was this a means to exploit the yen’s twice-in-a-lifetime rate of decline by clandestinely borrowing some of that excess valuation in Abe-san’s fast depreciating currency? We have no way of knowing, of course, but we remain duly suspicious. 

As for Japan itself, the yen’s fall has now matched the peak pace of that of the Sakakibara devaluation which started in the spring of 1995. In the sixteen months prior to that episode, it was the Chinese who had devalued, cutting the nominal yen-yuan cross in half before Mr (Anti)-Yen drove it up again by 80% in the succeeding three-and-a-bit years, and moving the ratio between the pair’s real effective exchange rates 110% higher along the way.

Lest it be lost in the mists of time, such gyrations were heavily implicated in, if not entirely responsible for, the last, least productive phases of the hot-money boom and the ensuing collapse in competiveness and shattering bust of most of the rest of Asia—‘Tiger’ economies and all.

Though technical targets for the Yen can initially be sketched to the Y110 level, a full-blown repeat of the mid-90s experience would take it all the way back to the mid-Y140s. Surely that couldn’t happen again, could it? Could it? It would surely take a heroic exercise of irresponsibility on the part of Kuroda & Crew even to contemplate; something crazy like—oh, let’s say—using derivatives to undermine the Yen.

Notwithstanding our initial lack of enthusiasm for the longer-term effects of the forex move on Japanese business profits and hence, employee and shareholder income, the market has not allowed any such cavil to hinder its rush to cut back on what is a widely-shared and long-entertained underweight position. This past three months, foreign buying of Japanese stock has hit, Y3.6 trillion, levels not seen since early 2007, while margin account balances on domestic exchanges have inflated by two-thirds in three months, jumping from near the lowest mark in 3 1/2 year to hit the highest in 4 1/2.

This has not only done some serious damage to charts of the Nikkei v other indices, but has also pushed it up beyond a grand trend-line in USD drawn off the unrivalled, Xmas 1989 high, the tech bubble peak, and all post-LEH recovery attempts.

Another 15% or so to the overall mid-point (with said trendline as a stop-loss area) is not beyond reasonable expectation, especially since the P/E is no longer in a league of its own (at 21.0 on the Topix v the same on the ASX, 22.8 on the Bovespa, 24.8 on the TAIEX, 37.1 on the KOSPI, 21.1 on the BE500, 18.3 on the FTSE, and 15.3 on the S&P), not to mention the fact that the index dividend yield—at 1.85%—is beyond anything on offer in the JGB market, exceeds any UST of under 9 years’ tenor, any Bund of less than 14 years to run, or any Gilt with less than 8 years remaining to maturity.

That may be crazy, but it’s certainly an accurate reflection of the world in which we live and of the policy intent of our lords and masters.

As for US equities, what is there left to say? Successive new highs are effortlessly being made on a daily basis; record buybacks are taking place (Miller-Modigliani and ESOP rules, OK!); multi-year heaviest mutual fund buying is underway; volatility is the merest whisker off its Crisis Era lows; margin debt is rising as fast as in 2000 and 2007; put-call ratios are depressed; the cumulative A/D stretches into the stratosphere; junk bonds are near yield lows; leveraged loan prices are back at Blue Sky, mid-2007 levels—and now the jobs numbers are giving everyone an all-over warm glow of Recovery-with-a-capital-R. 

The only thing to argue against this is that it’s simply all too good to be true; that it’s a function of the crazed, macroeconomic theorizing of a sixty year-old, wannabe-Oz sitting in an office on 20th St. and Constitution Avenue in Washington, D.C., a man who almost got on the Congressional record last week waspishly telling his interlocutor to quit belly-aching about the income on his aged mother’s savings and to get her into stocks instead.

For all that we are able to surmise that this is just the latest in a long series of bubbles, each one inflated in its turn in the attempt to ward off the reckoning due from the collapse of its lengthening family tree of predecessors, this all-encompassing experiment – not just with our livelihoods but with the wider structure of our very society – shows no signs of being called off. Rather, if anything, it seems it will be intensified in scale and extended in geography, to what ultimate end we can only dimly glimpse in our darkest imaginings. While that assumption holds general sway, the line of least resistance for risk assets is upward, no matter how otherwise groundless their rise.


The errors of Keynes

The Austrian School of economics has provided the world with devastating critics of Keynes’s magnum opus The General Theory of Employment, Interest and Money (TGT) for a long time. Friedrich A. von Hayek, Jacques Rueff, Henry Hazlitt, Murray Rothbard, Ludwig Lachmann, Ludwig von Mises, and William Hutt have already provided important arguments against Keynes and Keynesianism.

Now we can add a new name to that distinguished list. In 2012, Juan Ramón Rallo has published a new Austrian critique of TGT in Spanish with the title Los Errores de la Vieja Economía (The Failure of the Old Economics) in honor of Hazlitt’s work The Failure of the ‘New Economics’.

In Hazlitt’s time, Keynes’s program was still revolutionary and described by Hazlitt as a kind of “New Economics” that broke with the insights of classical economics and especially with Say’s Law. Now, Keynesianism is mainstream. Keynesianism, and especially its main idea that spending reduces unemployment, is still taught in universities, applied by grateful politicians, and prominently defended by the 2008 Nobel Prize winner Paul Krugman.

Indeed, the immediate political response to the current financial crisis in the Western World was inspired by TGT. A second Great Depression was to be prevented and Keynes’s insights applied. Governments engaged in loose monetary policy combined with fiscal stimulus in response to what, through Keynesian eyes, appeared to be a bubble caused by reckless speculation, which was in turn inspired by animal spirits. Thus, even if Rallo’s book were just a summary of the old arguments against TGT, the moment for publication would be more than appropriate, since the ideas of the past are still the praxis of the present.

Yet, Los Errores de la Vieja Economía is much more than a summary and synthesis of the old arguments by the aforementioned Austrian authors. Rallo builds upon, combines, and develops these arguments in a systematic way. Most importantly, he adds his own innovative ideas to develop a devastating case against TGT.

Rallo’s critique of TGT employing Austrian theory is rigorous, systematic and exhaustive. Significantly, Keynes’s ideas are not twisted or distorted. The absence of strawman arguments makes Rallo’s attack against the core of Keynesian beliefs stronger than most. Rallo also does not search for terminological contradictions and inconsistencies. In this sense, Rallo’s critique is more profound and devastating than for example the parts of Henry Hazlitt’s brilliant critique that emphasize Keynes’s inconsistencies, imprecision, and explanatory fuzziness. Rallo has a great and genuine interest in giving a clear and coherent picture of Keynes’s reasoning and presents Keynes in the most favorable light.

Let’s have a look of some of Rallo’s arguments, beginning with Keynes’s famous critique of Say’s Law. Keynes’s distorted version of Say’s Law in TGT states that supply creates its own demand. Rallo vindicates Say’s Law in its original version: in the long run, the supply of a good adjusts to its demand. Ultimately, goods are offered to buy other goods (money included). One produces in order to demand, which implies that a general overproduction is impossible.

Say’s Laws leads us straight forward to the most innovative argument in Rallo’s book that addresses the old argument against hoarding. Even harsh critics of Keynes, for example from the monetarist or neoclassical camp, admit that Keynes was at least right in that hoarding is a destabilizing and dangerous activity.

Rallo, however, proves and emphasizes the social function of hoarding. To demand money is not to demand nothing from the market. Hoarding is the natural response of savers and consumers to a structure of production that does not adjust to their needs. It is a signal of protest to entrepreneurs: “Please offer different consumer and capital goods! Change the structure of production, since the composition of offered goods is not appropriate.”

In a situation of great uncertainty, it is even prudent to hoard and not immobilize funds for the long run. Rallo provides us a visual example. Let’s assume that uncertainty increases because people expect an earthquake. They start to hoard, i.e., they increase their cash balance, which gives them more flexibility. This is completely rational and beneficial from the point of view of market participants. The alternative is to immobilize funds through government spending. The public production of skyscrapers is not only against the will of the more prudent people; it will also prove disastrous if the earthquake is realized.

Hoarding is an insurance against future uncertainties. Rallo argues that, if the demand for money increases (liquidity preference increases) due to the precautionary motive, short-term market rates of interest tend to fall, while long-term rates increase. People invest more short term and less long term in order to stay liquid. This leads to an adjustment of the structure of production. More resources will be used for the production of the most liquid good (i.e., gold in a gold standard), and for the production of consumer goods. The structure of production shifts toward shorter and less risky processes reducing longer and riskier ones. Hoarding, therefore, does not cause factors of production to be idle that shouldn’t be. Factors are just shifted toward gold production and shorter-term projects. Rallo insists that it is not irrational to hoard. Indeed, when long-term projects are maintained and economic conditions change, projects might have to be liquidated suddenly. For example, the earthquake would destroy the skyscraper in progress.

It should be noted that most Austrians do not hold a hybrid liquidity preference / time preference theory of interest. For Rallo the interest rate, or the structure of interest rates, is determined both by time preference and liquidity preference. Most Austrians defend the pure time preference theory of interest. My own position on this question can be found in this article co-authored with David Howden. Due to uncertainty an actor prefers to be liquid rather than illiquid. Due to time preference an actor prefers to be liquid rather sooner than later. Therefore, the yield curve tends to be upward sloping. When uncertainty increases, the yield curve tends to get steeper. In a financial crisis, however, another effect tends to prevail over this tendency. When society is in general illiquid, the high demand for short-term loans, the scramble for liquidity, tends to cause a downward sloping yield curve.

Idle resources are another important topic in Rallo’s book since Keynes recommends inflation in the case of idle resources. Rallo asks why factors are unemployed and comes to the result that their owners demand a price for their services that is higher than their discounted marginal value product. In these circumstances, inflation implies a redistribution in favor of the owners of those factors, or a frustration of attempts to restructure, i.e., the economy suffers from forced saving or capital consumption.

In contrast, when factors of production adjust their prices, i.e., wages fall back to their discounted marginal value product, aggregate demand does not fall as Keynes suggests. On the contrary aggregate demand increases, because total production increases.

Rallo goes relentlessly after other Keynesian concepts. The famous “investment multiplier” requires idle resources of all factors of production. More precisely, for Keynes to be right you need voluntary unemployment of all factors of production plus idle capacity in consumer goods’ industries. If there is no voluntary unemployment of all factors, government stimulation of new projects will lead to bottlenecks as factors are bid away from profitable investment projects. If all types of factors are idle, but there is no capacity in consumer goods industries, then government stimulus will raise prices of consumer goods and lead to a shortening of the structure of production. If, however, there is a general idleness of factors and idle capacities in consumer goods industries, why is there no voluntary agreement between owners of factors of production and entrepreneurs?

Another important Keynesian idea that Rallo tackles is the famous liquidity trap. A liquidity trap exists when, in a depressed economy, interest rates are very low. In such a situation Keynes regards monetary policy as useless, because speculators will just hoard newly produced money. Speculators will not invest in bonds because they are at maximum prices and will fall when interest rates finally rise. At this point monetary policy becomes impotent. Public spending becomes necessary to stimulate aggregate demand.

Rallo shows that after an artificial boom, in a situation where there are many malinvestments and a general over-indebtedness in the economy, there is indeed almost no demand for loans even at very low interest rates. We are actually faced with an illiquidity trap, as agents struggle to improve their liquidity. They want to reduce their debts and not take on more loans. The monetary policy of low interest rates actually worsens the situation, because with low interest rates, there is no incentive to prepay and cancel debts (because their present value is raised). The solution to this situation of general uncertainty is hoarding, stable institutions, the liquidation of malinvestment and the reduction of debts.

High uncertainty does not imply high unemployment, since even under high uncertainty the reduction of prices for services of factors of production renders profitable new projects. Under high uncertainty, these projects will be gold production (in a gold standard) and the short-term production of consumer goods.

As Rallo points out in contrast to TGT, it is not aggregate supply or aggregate demand that is important, but their composition. If, in a depression with a distorted structure of production, in a liquidity trap situation, aggregate demand is boosted by government spending, the existing structure cannot produce the goods that consumers want most urgently. The solution is not more spending and more debts, but debt reduction and the liquidation of malinvestments to make new and sustainable investments feasible.

In contrast, for Keynes, the problem is always insufficient demand. So what can we do if consumers and investors do not buy the goods of that companies offer, but instead hoard? Well, Keynes recommends lowering taxes and interest rates, to devalue the currency, or that the government buys the products for consumers. But, why, asks Rallo, should consumers and investors buy goods they don’t want?

Keynes’s answer is that otherwise unemployment will increase. Rallo responds astutely: but if a person is forced to buy with his salary something that he does not want, why shall this person work at all? The alternative to forced buying is to lower wages to their discounted marginal value product, which increases production and demand. As Rallo points out, society does not get richer if the government induces or forces people to buy goods they don’t want. Thus, for Rallo the essence of TGT is the following: when people do not want to buy what is produced, the government should force them to act against their will.

The insights from Rallo’s book presented here are only a small selection. Rallo also offers an analysis of Keynes’s main definitions and the theoretical errors behind them, such as their pro-consumption bias. He provides an Austrian analysis of financial markets, discussing the interrelations between the yield curve, interest rates, the discount rate, the structure of investment, the liquidity trap and the stock market. He analyzes real and nominal wages, business cycles, political implications, and intellectual predecessors of Keynes’s TGT using Austrian theory. Also very useful is Rallo’s guide for readers of TGT that makes reading and spotting Keynes’s main mistakes, chapter by chapter, easy and efficient. As a plus, at the end of the book, Rallo also provides a critique of the IS-LM model developed by John Hicks and Franco Modigliani which formalized Keynes’s theory and is still taught at universities around the world.

Rallo’s book on Keynes’s TGT is full of brilliant insights and provides the most powerful and complete case against Keynes currently available. The well-written Los Errores de la Vieja Economía will be the future reference for scholars and layman alike looking for errors in Keynes’s thinking and today’s policies. The main downside of the book is that it is written in Spanish. Hopefully, the work will be available in other languages soon.


So, what is wrong with Keynesianism?

Recently, someone left a comment on a post here along the lines of: “What’s your problem with Keynes?” One of the replies mentioned Hazlitt’s The Failure of the New Economics which is a critique of Keynes’s General Theory.

As that very book had been gathering dust on my bookshelves for a number of years I thought it was about time I actually read it.  So, I did.

And, what did I learn?  Sadly, not much.  I learnt that Hazlitt writes well but I knew that already. Economics in One Lesson is a masterpiece.  And he is on form here too.  His put downs of Keynes are tremendous fun:

I have been unable to find in it a single important doctrine that is both true and original.  What is original in the book is not true; and what is true is not original. (p6)

So I have found in Keynes’s General Theory an incredible number of fallacies, inconsistencies, vaguenesses, shifting definitions and usages of words, and plain errors of fact. (p7)

One reason Keynes’s thought is so often difficult to follow…, is that he writes so badly…. And one reason he writes so badly… is that he is constantly introducing technical terms that are not only unnecessary but inappropriate and misleading. (p16)

One begins to suspect that Keynes’ reputation, like Shaw’s, rests in large part on sheer impudence. (p346)

Keynes’s trick in this chapter is to mix plausible statements with implausible statements (p173)

The theory embodied in this paragraph is that the public is irrational, that it can be easily gulled, and that the object of government is to be the chief party to the swindle. (p245)

And so on.

But I was left with a problem.  Hazlitt’s criticisms may be witty and elegant but are they true?  I didn’t have the time to go through the whole of Keynes’s General Theory to check but I could at least have a stab at one chapter and see if it Hazlitt’s criticisms stand up.  Does Keynes say what Hazlitt says he says?  And is Hazlitt’s analysis correct?  I took as the sample chapter the one on the Multiplier.

Sadly, this experiment didn’t work.  Keynes is so opaque – even arch-Keynesian Paul Krugman admits it’s “tough meat” – that, try as I might, I couldn’t understand it. All I can say is that Hazlitt’s description appears to be correct. The idea that there is a causal relationship between current marginal investment and current marginal incomes appears to be absurd. To say that this relationship can be used to increase incomes seems doubly absurd.

At this point some wise words from Brian Micklethwait kicked in: if you can’t understand it that’s their problem, not yours.  It is up to Keynes (or his supporters) (and for that matter Mises and his) to make me understand what they are on about.  I will make moderate efforts and no more.

Of course, we are assuming that there is such a thing as “Keynesianism” to understand.  One of Hazlitt’s complaints is that he is constantly changing his definitions and contradicting himself.  I, myself, am aware that having described gold as a “barbarous relic”, Keynes went on to support its being part of the monetary system, before condemning it in the General theory and then supporting it again as part of Bretton Woods.

Now, people do change their minds over time.  I am sure there are differences in Mises’s thinking between The Theory of Money and Credit and Human Action but I suspect they are not that great – certainly nothing like as great as Keynes’s.

Still, I feel obliged to give Keynes one last chance.  If the theory can’t help us what about the practice?   I grew up in Britain at a time when Keynesian policies were being practised red in tooth and claw.  They didn’t work.  On two occasions – the early 1980s and the early 1990s – semi-Austrian policies were followed.  They did work.  I am not aware of any time or any place where Keynesian policies have worked and I am not aware of any time or any place where freedom (to give Austrianism its real name) – even in a watered-down form – did not.

As an aside I’ll allow Paul Krugman to have the final word.  This is what he had to say in an introduction to the General Theory in 2006:

One can identify a number of occasions, most notably Japan in the 1990s, where depression-like conditions might well have returned without the guidance of Keynesian economics.

Words fail me.


Deck the halls with macro follies

In case you missed it, here’s another gem from

In an article reprinted at, John Papola explains:

Each year, our attention turns to the holidays… and to holiday consumer spending! We’re told repeatedly that, because consumer spending is 70 percent of measured GDP, such spending is vital to economic growth and job creation. This must mean that savings, the opposite of consumption, is bad for growth.

This view of macroeconomics was first popularly asserted by Thomas Malthus in 1820, nearly 200 years ago. Malthus believed recessions were caused by “underconsumption” because there was a “general glut” of goods unsold. To recover from a recession and grow, we needed to stop all the saving and spend more to buy up all the goods on store shelves. Savers are like the miserly Ebenezer Scrooge. If you want a happy holiday, you’ve got to clear those shelves and give people a reason to produce more and create jobs. Or so Malthus thought.

John Maynard Keynes resurrected this approach and built on it with his influential “General Theory”, which now underpins much of our government policy and public discussion of spending and economic growth. Keynesians believe aggregate spending drives the economy and savings is a “leak” out of the flow of spending. Indeed, this economic philosophy underpins many people’s widespread obsession with retail sales each holiday season. Keynesian Macro Santa’s sack is filled with spending.

But there is another view on recessions, recoveries and growth.

Classical and Austrian economists such as Adam Smith, Jean-Baptiste Say and Friedrich Hayek viewed savings as the vital lifeblood of economic growth and production as the means by which we live better and consume more in the long term. Our savings aren’t simply taken out of the economic system, but become the source of capital that entrepreneurs use to create new goods and increase productivity. These economists believe this increased productivity is the key to a wealthier world. Before we consume, we must effectively produce what others value — at prices that cover the costs. This fundamental idea, that our demand for goods is enabled and constituted by our supply of other goods came to be known as the “Law of Markets” and later “Say’s Law”. For classical and Austrian economics, recessions happen when producers make mistakes. They create goods that can’t be sold at a profit. These malinvestments tend to cluster in a recession as a result of systematic problems, such as disruptions in the financial system and often government interventions in the economy.

Recovery and growth in the classical and Austrian view is driven by restructuring production so that entrepreneurs discover again the best — i.e. the most valuable and sustainable — ways to serve customers. That process is led by new entrepreneurs and driven by savers who make capital available to fund new investments and new ventures. Sustainable saving and investment means creating more value for others while using fewer resources. This process lies at the core of healthy economic growth, including better job opportunities and a rising standard of living.


Guido Hülsmann on Mises’s invaluable legacy

Download audio file: Guido Hülsmann on Mises’ invaluable legacy (29:45 min)

Episode 63: 2012 marks the centennial of the publication of one of the Austrian School of economics’ most important books on monetary theory: The Theory of Money and Credit by Ludwig von Mises. GoldMoney’s Andy Duncan interviews Professor Guido Hülsmann about his forthcoming special book – a “Festschrift” honouring Mises which will be published to mark this centennial.

They discuss the importance of The Theory of Money and Credit, along with the impact of a 1912 review of the book by a then little-known scholar by the name of John Maynard Keynes. Hülsmann uses Austrian theory as a basis for his predictions of how the global financial situation will develop. He thinks Germany will stay in the eurozone come what may, and also comments on the interesting case of two German members of parliament who were recently refused entry to the Bank of England and the Bank of France, after they requested to inspect German gold reserves stored at these institutions.

Hülsmann is a Professor of Economics at the University of Angers in France, and a Senior Fellow of the Ludwig von Mises Institute in Auburn, Alabama. He’s also the author of several important Austrian School books, including Mises: The Last Knight of Liberalism (2007) and The Ethics of Money Production (2008).

This podcast was recorded on 31 October 2012 and previously published at