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Last year, Steve Baker and I attended the Ludwig von Mises Supporters Summit in Salamanca, where I delivered my talk: “An Entrepreneur’s Tale: The Meltdown of 2008″. I described my experience of the credit crunch, and explained the insights that a proper definition of the money supply can offer. A video of the talk is now available: You can also hear a recording of my interview with Brian Micklethwait. This post originally appeared on stevebaker.info. Via The Telegraph.
But this begs the question, “Why is the money supply dependent on interest rates and government spending?” It turns out the great economist Irving Fisher told us back in the 1930s: banks create and destroy credit money by granting and calling loans. As Fisher wrote:
He went on (emphasis mine):
Fisher set out the problem in the 1930s and a solution, one which offered the possibility of paying off the national debt and largely ending economic cycles: 100% reserves on demand deposits. We face the same problem today and we have the same tantalising possibilities. There are politicians who understand: see for example the speech by the Earl of Caithness in the Banking Bill Debate 2009:
This is why colleagues and I established The Cobden Centre: we need honest money now to end the crisis and set us on a firm foundation for a sustainable and healthy future economy.
This article was originally published in October 2009. Many people know the Bank of England is creating new money through quantitative easing but if the quantity of money is being increased, how is that quantity being measured? What is counted as money? As the Bank of England explains:
But when I consider quantitative easing, I am concerned with the following problems:
As my colleagues point out in their working paper, the fact that the monetary authorities have turned to increasing the quantity of money will focus attention on how that quantity is measured. This article provides some background information and indicates Baxendale and Evans’ key findings. Continue reading “What is money?”
This article was originally published on 20 January 2010. It 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. I went to this event today. “22/02/2010 – Ideas Space Quantitative Easing: Friend or Future Foe? The Bank of England entered unchartered territory in January last year when the Treasury authorised it to begin a radical monetary policy experiment that we now know as “Quantitative Easing”. Given the unprecedented monetary conditions resulting from the liquidity crisis, the Asset Purchase Facility has been welcomed with open arms, and now stands at almost £200bn invested in UK gilts and corporate debt. But has QE had an economic impact to match its political use? Will the cure prove as dangerous as the disease? How and when should the Bank close the lid on this potential Pandora’s Box?” Several leading economic figures including Roger Bootle, Tim Congdon and Allister Heath, chaired by Policy Exchange’s Chief Economist, Andrew Lilico, will debate and discuss the merits of quantitative easing, the exit strategies for the Bank of England, the main challenges the UK’s economy will face as a result of the program in 2010 and beyond, and how policymakers should face them.” These are my notes: Tim Congdon spoke first , this basic message was that unless money supply, primarily bank deposits, is kept very tight and only moderately growing, there will be trouble ahead with boom or bust. QE has kept the economy on the road and the money supply has not fallen. He acknowledges that there were some problems in measuring this. Roger Bootle second, he opened by accusing one of our columnist, Liam Halligan of being intellectually devoid of any understanding of economics as he viewed Liam’s world to be predicated on massive inflation and a bond strike and this would never happen. He also said that QE could happen an infinitum. I tell no lie, this is what he said. In fact he was of the view that this should go on and on for whatever amount of time until we were out of trouble. People needed to believe that this policy was going to be the policy that would sort out the economy and indeed he agreed with Krugman, that crude of all the crude Keynesians, that Japan had actually done too little to stop the ongoing deflation. The UK’s risk was never going to be inflation but deflation. Allister Heath opened with saying he reluctantly supported QE as the key thing was to stop a monetary deflation but questioned why we were having a debate in the first place about the merits of QE and should we do more etc when we should be questioning why do we inflation targeting ? As this has given us the biggest boom and bust in living memory should we not dispense with this independent Bank of England , FSA and other so called control bodies and centralise further into one overall controlling body that controls the broad money supply? I was utterly bemused by all this tosh spoken in the name of economics with glimmers of hope only coming from Allister Heath. The chairman asked three questions and the audience were asked three questions with one follow up. I asked “in business I create wealth by making my factors of production work more efficiently to produce more goods and services. I invariably have to lengthen the structure of my production by saving and investing this money in new and more efficient kit to produce more of my goods and services for better prices and service level for my customers. With those goods I can exchange them with other entrepreneurs, shop keepers etc for my basic food, rent for my roof over my head etc via the medium of money. Money is bits of paper in this country and an electronic bank deposit, so having more of the bits of paper and banks deposits to exchange for the same goods and services would only mean my purchasing power had been debased, so no wealth would have been created. I thought this question go to the heart of the matter. The second was about bond yields – had they or had they not moved up or down. The third as about what the panel thought about the questioner’s view that we could only get out of this mess via and export related recovery. Peter Bottomley asked a question that I cannot remember. The Chairman then had another round of questions. Mine was relegated to the bottom by the Chairman. Roger Bootle thought it should be answered by Tim Congdon and in the end Allister Heath did give an answer which acknowledged that no wealth could be created by paper alone and that there was a large body of work in Mises and Hayek showing that the creation of credit causes boom and bust . He was reluctant to support QE as it at least kept money supply near static as opposed to imploding, but saw no ability for it to create wealth . I was not allowed time to debate this with Allister , but did mention afterwards that as he said to me, the Austrian School was divided between those who would support a printing of money to offset a fall in V and those who would just advocate a deflation to allow the market to clear at new lower prices. Having to go I should have added, there is a third camp based around the Cobden Centre who would advocate 100% reserves as this would fix the money supply and you can never have a run on the bank with 100% reserves in place. This is explained here http://www.cobdencentre.org/2010/02/a-day-of-reckoning/ . Allister framed his discussion in the mainstream language of the Quantity Theory of Money, more I suspect to engage with his fellow economists rather than he having any belief in it being more than a tautology. For a refutation of the Quantity Theory see here http://www.cobdencentre.org/2009/09/qe-errors/ . I did point out at the end after the event had finished that if V went down, how could me selling a house to someone, real bricks and mortar exchanging for money and having it sold back to me for the same 10 times create any wealth? Yes we can increase the velocity of the circulation of money by doing daft things like I describe, but Allister accepted nothing like wealth creation will come of it. The medium of exchange will not create wealth on its own. It is not wealth. If you hold these bits of paper you hold claims to wealth. The retained goods and the savings we have are wealth. The whole capital infrastructure of our companies and private balance sheets are wealth . This infrastructure drives wealth creation via the dynamic entrepreneurial spirit of men of action who mix the factors of production into the most efficient combinations to satisfy the most amounts of needs. No small matter of printing paper that facilitates exchange or adding electronic reserves to banks will make that wealth creation process any easier. The second part of this article explains how wealth is created http://www.cobdencentre.org/2009/09/can-the-manipulation-of-interest-rates-create-wealth/ . A poor day for economics! Drawing on the work of Nobel Laureates in economics from three traditions, plus numerous other distinguished scholars, Cobden Centre Chairman, economist and successful entrepreneur Toby Baxendale presents an informal introduction to our proposal for honest money and the benefits consequent on the reform. See also our precis of Irving Fisher’s 100% Money. Fact
 Sterling Liquid Assets (BoE FSR, Jun 2009) A practical, politically-acceptable proposalOur proposal is, as Irving Fisher wrote, “The opposite of radical”:
A similar Act took place in 1844. The Bank Charter Act or “Peel’s Act” established a 100% reserve requirement for bank notes that were issued claiming to be redeemable in gold. The reality was that there were 23 notes in issue for every one unit of gold at the time, creating instability, “panic” and general economic chaos. Not a too dissimilar situation from today where we have 34 claims on money to one unit of money. Politicians in the 19th century did not see the creation of unbacked credit through accounting entries as a problem, since it was only done on a very small scale. The problem then was rampant note issue (claims to real money) well over and above the monetary base, as this was the preferred method the bankers used at the time. It is often forgotten but when you place £1m in a savings account (in cash) in say the Royal Bank of Scotland, which has no legal reserve requirement, they then lend £970k (in credit) , keeping on average 3% of cash back in reserves, to an entrepreneur in say HSBC, who then deposits that money in HSBC. We now have one claim to the original £1m and one claim to the £970k. The money supply has moved from £1m to £1.97m – just like magic! This is credit expansion. The reality is that across all the banks in the United Kingdom licensed by the Bank of England, we have for every £1 of money (in cash), £34 in claims to money (credit)! Peel’s problem was the over issue of notes to gold: our problem is the over issue of credit to money. Continue reading “A day of reckoning: how to end the banking crisis now”
A speech to the Policy Exchange on 31st March 2009 by Cobden Centre sponsor James Tyler. This article first appeared on hedgehedge.com. 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. Via Don’t Blame the Federal Reserve – Stephen Mauzy – Mises Institute:
Via Labour’s dishonesty is leading us down the road to sovereign default, Liam Halligan launches a scathing attack on Alistair Darling, Gordon Brown and British political class:
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In their working paper