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By James, on 3 March 10
Some people doodle pictures, but I’m the type who mucks around random bits of historical price data just to see where it goes. For example, I love charts of the Dow Jones Stock index in the 1920s – it me it tells a vivid story of hopes and dreams and pain mixed with desperation. The wild fluctuations in the early 20’s, the solid gains of the mid 20’s then the euphoria and ensuing panic, well.. you know the rest.
A while a go, I came across a quote;
With an ounce of Gold, a man could buy a fine suit of clothes in the time of Shakespeare, in that of Beethoven and Jefferson…
What does a ‘fine suit’ cost today? Well, an ounce of Gold is just short of £700. If you went into Harrods, and asked for a fine suit, would that see you into an Armani or Zegna number? I think so.
So, the maxim seems to ring as true today as it ever did.
So my mind got to thinking – if an ounce of gold seems to buy the same stuff over the centuries as it does today, then it would seem to be a great proxy for true purchasing power.
The problem with looking at historical charts of stock movements, especially if you are trying to learn the lessons of history, is that the picture is muddied by the fact that the unit of account – i.e. money, does not do a very good job. It is rapidly decaying so when you compare over time, it just gives the wrong impression of what is going on.
For example, look at the stock market over the whole of the 70’s, and you think that equities didn’t do too badly. But adjust for inflation, and you soon realize that stocks lost over three quarters of their value in the first half of the 70’s!
So, the idea dawned on me: the price of stocks and shares are only represented in terms of money. What if you priced them in Gold instead of pounds and dollars?
Firstly: what data? Well, I stuck to the UK, and I chose the FTSE all share index. I took the index value for each day, going back a few decades. I then converted them into ounces of gold. The chart gave me a pretty shocking picture.
But then I realised I’d missed something pretty important. Stocks pay dividends. So, I added a 5% annual dividend return, and then reinvested it into my index. Surely that’d make my chart look less ridiculous? Erm, a bit… but not by very much.
What I was left with was a completely different view of history, and some pretty worrying revelations.
Firstly, my chart had nothing to say until the 70’s. This is because until then, money was gold – therefore priced in money or gold – it didn’t make a difference. In essence, the chart had no surprises.
But in the 1970’s, money was cut loose from gold, with some pretty shocking results.
 FTSE All Share in terms of in oz of Gold (click to enlarge) Some salient observations.
1. The mayhem of the early 70’s had some pretty catastrophic consequences for the world, and recovery only came in the 1980’s. From over 12 ounces of gold, down to nearly 1 ounce of gold is a pretty insane move.
2. Real growth took off in the 80’s, but something happened in the mid 90’s – the internet. This was a period of real economic growth, that morphed into a bubble, thanks to some pretty silly policy mistakes by Greenspan et al.
3. What happened in the 00’s? Wasn’t that supposed to be the ‘NICE’ decade? Wasn’t the stock market supposed to have risen back to its peaks?
My answer to this is that the noughties were a period of stagnation, economic misalignment, and we were all swamped by a money fraud.
The authorities were in such a blind funk in 2001, with the overriding perception that we were facing a 1929 style collapse, that they turned on the money gusher, and flooded the whole world with liquidity. This found its way into the greatest worldwide property bubble the world has ever seen.
But… this was not true growth – at least for the Western economies. Sure, great advances were made in some sectors of their economies, but huge misalignments of capital were occurring, and this decade of false signals to producers, but especially to Western consumers, is why we had the economic crisis of 2008.
Look where we stand now. In ruinous debt. Shackled to low interest rates and nervously watching retail sales and property prices. This is a direct consequence of our societies living the high life for ten years, without actually realising we were in decline.
We have been living like cannibals. Hollowing out ourselves out, yet living the high life. And this is all down to a pseudo neo-Keynesian/monetarist aggregate kabala fetish.
I feel a sense of panic looking at this chart, so what is the solution?
Free markets built on the bedrock of honest money.
By Liam Halligan, on 17 February 10
Could the endgame of this “Greek tragedy” be a eurozone break-up? The single currency’s supporters maintain such an outcome is mere mythology. Greece accounts for only 3pc of the 16 member states’ combined GDP, they say, and has lower debts than some of the banks bailed-out during “sub-prime”. A loan of €20bn (£17.5bn) would do the trick, we’re told. That’s less than the British government injected into either Lloyds or the Royal Bank of Scotland.
Such analysis sounds vaguely plausible. But its naïve and politically dishonest. Then again, the single currency was built on political dishonesty. That’s because, at the heart of the eurozone project there was always a fundamental contradiction – one the architects of monetary union never dared to address. Now its being highlighted for them, whether they like it or not.
While the European Central Bank controls eurozone interest rates and the money supply, the size of each country’s fiscal deficit results from the spending and taxation decisions of its own sovereign government. How can you enforce collective fiscal discipline in a currency union of individual sovereign states, each answerable to their own electorate? The truthful answer is you can’t – not unless you subjugate the autonomy of democratically-elected politicians and, by proxy, their voters.
Voters don’t like that. Neither, do politicians. Faced with a choice between seriously annoying their own voters and seriously annoying the ECB, the most ardently “pro-European” lawmakers, even those with years of Brussels trough-nuzzling under their belt, will always side with their own. That’s why the eurozone will ultimately break-up – whether Greece is bailed-out or not.
The eurocrats blame “speculators” for the single currency’s woes. That’s a bit like sailors blaming the sea. The eurozone is ultimately doomed because, in the end, economic logic wins and the will of each country’s electorate bursts through. This current Greek saga won’t end the eurozone – but future historians will identify it, perhaps, as the beginning of the end.
Many have said it’s hardly surprising that Greece – with its history of financial profligacy and capital flight – has emerged as the eurozone’s Achilles heel. A more germane observation is that, while fiscally wayward, Greece is also the birthplace of democracy. If the Greek population wants to get upset, throw out its elected politicians and reject austerity, it must be allowed to do so. I think they’d be mad, but it must be their choice.
If Berlin and Brussels try to impose their own view on Greece and the “cuts” come from outside, the situation will become incendiary. Protests will turn into fully-blown riots. Greece will endure very serious social unrest. Deep-seated rivalries and suspicions between countries will be re-ignited. And for what?
Greece is running a budget deficit of 12.7pc of GDP. The real number could be 15pc or more as Greek politicians have lied for years about the extent of their country’s liabilities. They’re not the first European leaders to do so and they won’t be the last. But Greece was, almost uniquely, assisted in its fiscal cover-up by Brussels – with the usual “convergence criteria” being bent to allow Greek euro entry.
As recently as September 2008, the euro seemed to be going well, despite the massive variation between member states. The five-year Greek credit default swap spread was less than 50 basis points. In other words, buying insurance against Greece reneging on its sovereign debt cost only slightly more than insuring German government bonds. Those, such as this columnist, who continued to warn that the eurozone was “dangerous and inherently unstable” were dismissed as cranks, xenophobes or worse.
Then sub-prime hit in earnest. Insuring against Greek default suddenly became a lot more expensive, the CDS spread rising six-fold in eight weeks. The same risk measure is now around 400 basis points, the cost of insuring against Greek default no less than 20 times higher than it was in January 2008. Default risks are growing in Portugal and Spain too, the eurozone’s fourth biggest economy.
The problem is that default dangers in Greece – where €20bn of debt falls due in April and May – are making creditors think twice about lending to other cash-strapped governments. Even if Greece avoids default, this latest crisis means governments everywhere will have to pay more for their finance, which in turn will push up borrowing costs for everyone – right across the eurozone and beyond, including in the UK. This is so-called “contagion”.
The Greek government has been desperately trying to convince the rest of the world – the Germans in particular – that it will keep its promise to reduce the deficit in its still-shrinking economy to 8.7pc of GDP next year and less than 3pc by 2012. Yet this would amount to the most severe fiscal contraction in the history of modern Europe. It simply won’t happen.
The reality is that Greece has two choices – both disastrous for the eurozone. One is to default, leave the euro and re-establish the drachma at a rate low enough to stimulate exports and growth. To write this is heresy. But with general strikes now in the offing, and the Greek public-sector unions resurgent, such a scenario is possible.
For years, the ECB has set rates low to suit France and Germany. This has made life difficult, causing dangerous debt bubbles, in smaller and more inflation-prone eurozone members. Were Greece to take the exit route, the governments of several other single currency members would come under intense pressure to do the same. The eurozone’s vital cohesion would be seriously undermined. Its ultimate break-up – or, at least shrinkage to a Franco-German rump – would only be a matter of time.
The other, more likely, option is that Greece accepts a German-led bail-out and “muddles through”. But even that would spark an eventual eurozone split. On extending assistance, Berlin and Brussels would talk tough and Greece would promise to behave. Anything less wouldn’t be tolerated by German voters. After the horrors of inter-war hyperinflation, Germany has spent more than 50 years building policy credibility. Backing a Greek bail-out would be a massive step – the first time in decades Germany has departed from its fiscal and monetary hard line.
Yet the German government will do it. Refusing to bail-out Greece would risk being labelled “bad Europeans” – something anathema to Germany’s post-war elite. Berlin also has a massive financial stake in the euro’s status as the world’s second most-used reserve currency.
Although Greece will be presented as a one-off, a “very exceptional” case, once that line has been crossed there is no going back. Other eurozone countries will want a bail-out. Why should Portuguese, Estonian or Spanish workers endure austerity and unemployment, while those in Greece were spared? Why them and not us? If big banks can compete for bail-outs, walking the line of “moral hazard”, political leaders will do so too. A Greek rescue by the Germans would spark repeated bail-outs.
In the end, voters in the big eurozone economies, faced with their own fiscal problems will say enough is enough. Europe’s monetary union will collapse, just like every other currency union in the history of man. The exception is America – yet the US, as the eurocrats hate to acknowledge, had been through a century and a half of political union before the Federal Reserve was founded in 1913.
That’s the key difference. America is a political union, with a system of explicit inter-regional fiscal transfers, and the eurozone isn’t. That’s why the single currency will ultimately split and be exposed as what it is – a triumph of European hubris and political vanity over unavoidable economic logic.
By Toby Baxendale, on 16 February 10
The answer is that the US dollar has lost 98.17% of its purchasing power and the pound sterling 99.42% of its purchasing power. Well done then, I suppose, for surpassing even the great tyrants of old who plagued the citizenry of both nations!
Some History
Gold was money for a large part of mankind’s history.
It was discovered by early man to be the most marketable of commodities. As such, the free interaction of people led to this commodity being adopted as the final thing for which all goods and services were traded. This discovery allowed man to lift himself from direct exchange, or barter, of his goods and services to indirect exchange. This indirect exchange allowed the universal application of the division and specialization of labour that has, in turn, given us all the material prosperity we have today. The discovery of money, then, must rank along with language as arguably the most important invention or discovery in the whole course of human history.
Note that, like language, money was not created by the State but by the private and spontaneous interaction of free individuals.
There are many stories in history of wicked monarchs who, to fund their various despotic regimes or lifestyles, would call in the coinage of the realm, extract a small percentage of gold — a “clip” — and then add an impurity before giving them back to the public; this is debasing of the monetary unit. This embezzlement was unlawful for the minter in the private sector and many people over the ages have been executed for stealing from money owners in this way but the monarch usually got away with it. One of the most notable examples in history was when Emperor Nero reduced the value of the denarius from being pure silver weighing 4 grams to 3.8 grams. His financial gain was enormous.
Another great example of history is our very own tyrant per excellence, Henry the VIII. He reduced the weight of sliver in the silver penny to 1/3rd of its purity from 0.925 to 0.250. By the reign of Elizabeth I, the Tudor financier Sir Thomas Gresham had to negotiate a loan from the Antwerp traders to provide more money for her nation. Sir Thomas came back and said
It may please your majesty to understand, that the first occasion of the fall of exchange did grow by the King majesty, your late father, in abasing his coin … which was the occasion that all your fine gold was conveyed out of this your realm.
What became know as Gresham’s law is that “Bad money drives out good under legal tender laws”. In Europe this is know as the Copernicus Law, as he was saying the same thing on the continent. The great medieval philosopher and theologian Nicole d’Oresme was the inspiration of Copernicus on this matter.
Economics of the Matter
A debasement always meant an inflation. Why? As there was more coinage in circulation chasing a similar amount of goods and services for sale, prices rose.
No less a figure than John Maynard Keynes in Economic Consequences of the Peace (1920), said:
By a continuous 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.
This is from a man whose current disciples are inflating the western world’s money supply to a point that can only lead to rampant inflation.
We should remember the names which we have used to label money historically. In the UK “sterling” and in the USA “dollar” each described a fixed weight of gold . Gold was the money unit, not sterling or dollar in itself.
Before World War I the pound sterling was worth $4.86856 and a dollar was worth 1/20th of an ounce of gold. For the sake of simplicity I will say that the pound sterling was defined as ¼ of an ounce of gold and the USA dollar 1/20th of an ounce.
So How Much is my Pound Sterling Worth Today?
The Maths
One ounce of gold today is worth $1,093.40 and 1/20 oz therefore $54.67 but the dollar pre World War I was just a name in the USA for 1/20 of an ounce of gold: what would have cost $1 before World War I would cost $54.67 today. The dollar has lost its purchasing power. In fact it has lost 98.17% of its purchasing power in 100 years. One dollar today should buy something like a single person’s weekly food shop, not a single daily newspaper.
The fate of the pound sterling has been even worse than that of the dollar. One ounce of gold today is £692.26. So if a pound sterling pre World War I was just a name in the UK for 1/4 of an ounce of gold, it would imply that the pre World War I purchasing price was 1/4 of £692.26 or £173.06. In fact the pound sterling has lost 99.42% of its purchasing power in 100 years. One pound should buy something like a good week’s food shop for a familiy of four and not just one daily newspaper like it would today.
Conclusion
Our modern day Neros and Henry VIIIs are those we call our Prime Ministers and our Presidents. We are told they are all well meaning men and women. That may well be the case. They have however, since World War I, sat on the single greatest debasement of our wealth in human history.
They do this via the monetization of their nations’ debt. A politician in power might have promised to give X, Y or Z group of people £X, £Y and £Z in exchange for voting for them. If the tax revenue is not enough, then they simply, out of thin air, either create more money — old style monetizing the debt to pay off the debt obligation — or, with a computer key, they open up a new bank deposit for themselves to pay or buy back some of their debt. This is called “QE” or Quantitive easing and we discuss the errors associated with it here.
Last year the UK raised over £200 billion by one part of the government issuing debt and the other part buying it. So £200 billion of new money is now in circulation. Nero and Henry VIII would blush at the brashness of this debasement. This is done wholly at the expense of yours and my very own purchasing power.
The Cobden Centre exists to promote honest money and social progress. Honest money is money that cannot be debased by governments to pay off liabilities they have incurred over and above their tax revenue. I outlined a banking reform proposal which advocated 100% reserve money here. Staying within the existing paper money regime, one would need a bill to prevent the new issuance of either paper money or computer generated new bank deposits by the government. Ultimately, we must look at fully re rooting our paper money back into solid commodities that the government cannot destroy or create at will.
Further Reading
- Huerta de Soto, Money, Bank Credit and Economic Cycles
- Baxendale, A day of reckoning: how to end the banking crisis now
- What is wrong with banking, part 1: the legal nature of banking contracts
- Frank Whitson Fetter, Development of British Monetary Orthodoxy 1797 – 1875
- F. A. Hayek, Denationalisation of Money: The Argument Refined
- Gordon Kerr, How To Destroy the British Banking System and Bailing out the Banks – Glaring Evidence of Moral Hazard
- James Tyler, My Journey to Austrianism via the City, Money is not working and How to avoid future encounters with financial meltdown
- Irving Fisher, 100% Money, 1935
By Steven Baker, on 15 February 10
 Dowd, Alchemists of Loss We are delighted to announce a forthcoming book by Cobden Centre Senior Fellow Professor Kevin Dowd and US-based journalist and former investment banker Martin Hutchinson: The Alchemists of Loss: How Modern Finance and Government Intervention Crashed the Financial System. The book contains some delightfully simple insights into a complex subject. For example:
The credit default swap sneaked up on everybody, becoming a $62 trillion market, without anyone outside the business knowing much about it. As the Bear Stearns, Lehman and AIG debacles revealed, these instruments also involved highly non-transparent credit risks of their own. As a holder of a CDS you don’t know whether your counterparty has issued only a few of your CDS, in which case you’ll probably get paid in a bankruptcy, or whether he has issued fifty times the outstanding debt you’re trying to hedge, in which case you’re unlikely to get paid.
And moreover:
Financial engineering’s benefit to the global economy is highly questionable and the proliferation of financially-engineered products of recent years has brought few benefits and led to huge losses for society at large. As we have seen, one quarter’s bad losses in late 2008 wiped out all the accumulated financial engineering profits of the last quarter century and saddled taxpayers with a bill for hundreds of billions, if not more.
Prof. Dowd has kindly agreed to pre-release two chapters through The Cobden Centre:
From Chapter 16:
Alert readers will have already picked up some of the advice we would give investors and clients of financial institutions:
- take a longer-term perspective and return to investment rather than speculation;
- do not seek to ‘enhance’ yields, because this always exposes investors to hidden costs and risks, whilst firms seeking finance should resist cutting corners on their financing costs, for the same reason; thus, both parties should be realistic in their expectations;
- avoid frequent trading, focus on static over dynamic strategies, buy and hold over activist portfolio management;
- pay more attention to costs and hidden charges, and work on the assumption that higher charges are usually a good signal of a bad deal;
- distrust commission-based salespeople;
- if you use derivatives, be clear why and use them only for risk management and not speculation;
- avoid complicated opaque products; and
- do not take liquidity for granted and ensure that your liquidity is protected in a crisis.
Besides this motherhood and apple pie stuff, investors should also be careful of correlation-based investment and risk management strategies, which work well when not needed but are apt to break down when they are. This is not to suggest that they should give up on diversification. People understood diversification long before Modern Portfolio Theory, but they tended to practice it differently and more wisely. Diversification was assessed by committees of experienced practitioners, who took a long-term view and relied on their judgment rather than unreliable correlation estimates – a far cry from modern practices of modern fund management, with its obsession with short-term performance assessment
Investors should demand transparency. Perhaps the most sobering lesson we have learned since the subprime crisis broke is the benefit of transparency in business dealings. Time after time, when a fiasco has occurred, a key contributing factors has lack of transparency. Subprime mortgages, CDOs and credit default swaps were all financial innovations that relied crucially on nobody asking too many questions. So too with the vast Madoff Ponzi scheme, involving some of the most sophisticated investors in the world, which rested on the same fatal human omission.
Download Chapter 16 to read on.
From Chapter 17:
The restoration of a rational and stable financial system inevitably requires major reform on a number of fronts. History gives much guidance here and also a role model: the period we should seek to emulate is the nineteenth century. Then money was sound, the dominant currency of the time, the pound, was literally as good as gold, while financial institutions were conservative and generally stable, and an altogether healthier financial ethos reigned.
It is very common these days to sneer at the gold standard: after all, it was Keynes who once dismissed it as “a relic from a barbarous age”. We would suggest, on the contrary, that a gold standard or some suitably 21st Century commodity equivalent would be highly desirable, and put an end to the disastrous century-long experiment with fiat money and its attendant miseries of inflation and monetary instability. The fact that Keynes opposed the gold standard is a further reason to support it.
The nineteenth century model would also entail major reforms to financial institutions and the regulatory system: greater liability and greater responsibility, the repeal of deposit insurance and investor protection legislation and the abolition of the big financial regulatory bodies such as the SEC and FSA. And by nineteenth century standards, we really mean early nineteenth century standards, those that pertained to the period before the Bank Charter Act of 1844 and the Companies Act of 1862, when liability was very real.
As for the banking system, we would suggest that the role model is Scotland pre-1845, when the Scottish banking system was virtually free of state control, unhindered by a central bank, and equally admired and envied across the world – and copied by countries such as Canada and Australia. In all three countries, free banking systems operated highly successful for very long periods of time. Indeed, the Canadian system was widely admired in the United States – and many US reformers in the late nineteenth century saw it as their ideal. The Canadian system was highly stable – apart from the failures of two small Alberta banks in 1985, its last notable bank failure was that of the Home Bank of Canada back in 1923. There were no Canadian bank failures in the 1930s and, even after the establishment of the Bank of Canada in 1934, many still regard the Canadian banking system as the best in the world.
Our first choice environment would be one with a commodity standard, free banking (no central bank) and financial laissez-faire, restrictions on the use of the “limited liability” corporate form and the most limited government. Even if we don’t return all the way to these early nineteenth century standards (and we can imagine the opposition!), we should still move as much as possible in that direction, though we would not advocate the reintroduction of the notorious debtors’ prisons immortalized in the fiction of Charles Dickens! However, our proposed reforms herein are adapted to the “second best world” (if it’s actually that; it may be about thousandth best of all the ‘parallel universe’ possibilities) in which we live, with relatively large government, a fiat currency and a central bank.
The most important institutional policy that must be solved is that of an excessively expansionary monetary policy. Simply making the monetary authority “independent” does not achieve this if the monetary authority retains its interactions with politicians and the financial community, both of which want loose money. The ideal to aim at is a hard money Fed, a Paul Volcker Fed.
Download Chapter 17 to read on.
You can also pre-order Alchemists of Loss at Amazon.
Further Reading
- Huerta de Soto, Money, Bank Credit and Economic Cycles
- Baxendale, A day of reckoning: how to end the banking crisis now
- What is wrong with banking, part 1: the legal nature of banking contracts
- Frank Whitson Fetter, Development of British Monetary Orthodoxy 1797 – 1875
- F. A. Hayek, Denationalisation of Money: The Argument Refined
- Gordon Kerr, How To Destroy the British Banking System and Bailing out the Banks – Glaring Evidence of Moral Hazard
- James Tyler, My Journey to Austrianism via the City, Money is not working and How to avoid future encounters with financial meltdown
- Irving Fisher, 100% Money, 1935
By Tom Burroughes, on 11 February 10
 The Financial Times has an item up about the weight of investor pressure to sell the euro, taking the view, no doubt, that the financial crisis affecting debt-laden Greece could raise the chances of a breakdown in the single currency bloc:
Traders and hedge funds have bet nearly $8bn (€5.9bn) against the euro, amassing the biggest ever short position in the single currency on fears of a eurozone debt crisis.
What interests me about this saga are not the specifics of the Greek financial debacle – which is, in my view, a particularly egregious example of fiscal incontinence by that country’s government – but rather what the FT story tells us about the benefits of short-selling.
The practice of shorting, which describes the process of temporarily borrowing a financial instrument such as a currency, selling it and repurchasing it at a cheaper price to pocket a profit, has sometimes been politically attacked. About two years ago, the UK government decided that those wicked investors who had been shorting the securities of banks such as HBOS needed to be warned off. It was if the very idea of seeking to profit by taking a negative view of a stock or bond was “unpatriotic”. In their defence, policymakers might argue that they were trying to prevent frenzied attacks on a company or country, but all too often, attacks on shorting turn out to be a classic case of “kill the messenger”. I hold no great admiration for George Soros, given his political views, but he certainly did the UK a favour, in my view, in shorting the pound in 1992, a process that eventually helped drive the UK out of the European fixed exchange rate system at the time.
Likewise, in the latest example of foreign exchange drama, traders who are shorting the euro are sending out a powerful message: this currency has a great big flaw in it. Can, for example, the relatively big economies of Germany and France be expected to bail out Greece in the way that say, the Federal US government might have to bail out California, a state that has been teetering on the brink of collapse for months? Such a bailout would only raise the question of whether countries doing the bailing out were entitled to have a more direct say about the fiscal policies of a member state.
Healthy Shorting, in any event, is part of a healthy, liquid financial market. Without those who are willing to sell, buyers cannot operate (a point so obvious that I feel a bit embarrassed to have to even mention this on this site). If we want efficient price discovery to work in markets, then it should be possible for operators to profit not just from when a price rises, but when it falls. Shorting can enable financial players to hedge risks.
Of course, part of the issue for those monitoring the markets is that the routes by which an investor can short a stock have multiplied. You don’t have to be a big hedge fund with access to a powerful prime broker such as Morgan Stanley or Deutsche Bank. You can, for example, short a security through derivative-type products such as contracts for difference (CFDs) and spread-betting, both of which are instruments open to the retail investor, given certain constraints. These processes can be accessed online via firms such as IG Index, for example.
So armed with such instruments, traders can express a bearish, as well as bullish, opinion. And the FT story is striking about what the euro bears think. For example, the report says that traders and hedge funds have bet nearly $8bn (€5.9bn) against the euro, “amassing the biggest ever short position in the single currency on fears of a eurozone debt crisis”.
Figures from the Chicago Mercantile Exchange, which are often used as a proxy of hedge fund activity, showed investors had increased their positions against the euro to record levels in the week to February 2.
It has been one of the ironies of the financial turmoil that when problems first arose, it was easy for the European nations such as Germany and France to hint that their systems were so much more robust than the approach taken by those cowboy Anglo Saxons. But in truth, EU countries, many of which now have levels of debt that are alarming investors, have big problems. Short-sellers are simply expressing the wider worries that investors have about the viability of the euro and the willingness of euro zone states to operate a sound currency.
By Jamie Whyte, on 10 February 10
Last year two police women (WPCs) were discovered to have a reciprocal child-minding arrangement. It was initially declared unlawful. Child minders who receive payment for their services must be registered with Ofsted. And receiving payment is not restricted to receiving money. Anything of value counts, including “free” minding of your own child. These unregistered WPCs were wrongdoers.
Public outrage at the absurdity of preventing friends from looking after each other’s children caused Ed Balls, the Secretary of State for Children, Schools and Families, to intervene. He declared that reciprocal childminding was not a kind of payment after all. The WPCs congratulated him on this small victory for common sense.
Which just goes to show that the common sense of WPCs cannot be relied upon. For, despite Mr Balls’ great powers, he cannot by mere proclamation stop reciprocal childminding from being a kind of payment. His decision simply exempts this barter payment from the tax that Ofsted’s rules and registration fees impose on childminding when other forms of payment are used.
If one of those WPCs quit her police job but offered to continue minding her friend’s child for £50 a day, Ofsted’s requirements would reimpose themselves. The child may be cared for by the same person in the same place, but the introduction of money to the deal would bring with it the state’s administrative and financial burdens. Mr Balls’ “common sense” intervention thus encourages a barter economy in childcare.
This is a silly thing to do. Because money is a better method of payment than barter. While the WPCs barter, they can consume the value of the childminding work they do only in the form of childminding for themselves. This means that they will restrict the amount of childminding they supply to the amount they want to consume. If they paid each other in cash, this restriction would disappear.
As all economists know, money increases the opportunities for trade. Limit its use and many potential transactions will not take place; valuable goods and services will not be produced. And, when they are, they will often be produced by the wrong people.
For where money-based exchange is restricted, people must produce a wider range of goods, either for their own consumption or to increase the chance of having something they can swap for something they want. This is unfortunate, because the more things you do, the worse you will be at them.
In short, discouraging the use of money constrains trade, which limits the division of labour, which leads to inefficiency. Politicians ought not do it. Yet they do it all the time. They impose burdens on activities when done in exchange for money that they otherwise leave alone.
Consider the minimum wage. I am not allowed to pay someone £4 to spend an hour shopping for me. According to our government, that would be unfair, even if my employee agreed to it. Yet I am free to add an hour to my own shopping by walking to a distant supermarket in search of a £4 saving.
I am also allowed to spend an hour cooking my dinner, even if I would be unwilling to pay someone more than £3 to do it for me. Contrary to what you may have read on the Directgov website, working for less than £5.80 an hour is not illegal in Britain. It is illegal only if the payment is made in money.
Taxes have the same effect. Since most are levied on money-based transactions (with the notable exceptions of poll and property taxes), they inhibit trade and, hence, the division of labour. And the greater the rate of tax, the greater this malign effect.
Suppose, for example, that you are willing to pay up to £10 an hour to have some work done, and that the cheapest qualified labourers are willing to work for anything over £9 an hour. Then you should find someone to do the job. But if incomes are taxed at 20 per cent, the most the labourers can earn from you is £8 an hour and they will be unwilling to take on your job. You will have to do it yourself or go without.
Britain’s enormous regulatory and tax burdens on trade lead to an excess of do-it-yourself. People with neither talent nor inclination cook, garden, teach, drive and shop, to name but a few of the more common amateur activities. They are thereby drawn away from doing things they are better at and enjoy more.
What is the cost of such restrictions on the division of labour? Terry Arthur of the Institute of Economic Affairs has estimated that, at current tax levels, the cost is two thirds of every pound of tax collected. In other words, the marginal cost of transferring a pound from private hands into the coffers of Her Majesty’s Revenue is 67 pence.
Mr Arthur may be wrong, of course; estimating such “invisible”, deadweight costs is notoriously difficult. But even if his estimate is three times the real cost, the implications are profound. Taxes, minimum wages and the other regulatory burdens the government places on money-based commerce are far more costly than politicians and voters seem to realise.
Indeed, most do not recognise this cost at all. Some lament the futility of a system in which people are taxed only to receive their money back in the form of government provided services, such as education and healthcare. But they fail to see that the spinning of this money-go-round creates a terrible economic drag.
Alas, there is no prospect of an end to this waste, even if politicians understood it. When invisible costs are incurred for the sake of visible benefits, a politician will never consider them too great.
By Anita Acavalos, on 8 February 10
Guest contributor Anita Acavalos, daughter of Advisory Board member Andreas Acavalos, explains the political and economic predicament in Greece.
In recent years, Greece has found itself at the centre of international news and public debate, albeit for reasons that are hardly worth bragging about. Soaring budget deficits coupled with the unreliable statistics provided by the government mean there is no financial newspaper out there without at least one piece on Greece’s fiscal profligacy.
Although at first glance the situation Greece faces may seem as simply the result of gross incompetence on behalf of the government, a closer assessment of the country’s social structure and people’s deep rooted political beliefs will show that this outcome could not have been avoided even if more skill was involved in the country’s economic and financial management
The population has a deep rooted suspicion of and disrespect for business and private initiative and there is a widespread belief that “big money” is earned by exploitation of the poor or underhand dealings and reflects no display of virtue or merit. Thus people feel that they are entitled to manipulate the system in a way that enables them to use the wealth of others as it is a widely held belief that there is nothing immoral with milking the rich because they are commonly perceived to be everything that is wrong with Greek society. In fact, the money the rich seem to have access to, is the cause of much discontent among people of all social backgrounds for example farmers and students. The reason for this is that the government for decades has run continuous campaigns promising people that it has not only the will but also the ABILITY to solve their problems and has established a system of patronages and hand-outs to this end.
Anything can be done in Greece provided someone has political connections, from securing a job to navigating the complexities of the Greek bureaucracy. The government routinely promises handouts to farmers after harsh winters and free education to all; every time there is a display of discontent they rush to appease the people by offering them more “solutions.” What they neglect to say is that these solutions cost money. Now that the money has run out, nobody can reason with an angry mob. Continue reading “I predict a riot”
By Toby Baxendale, on 4 February 10
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
- The average overhang of credit to money of all banks in the United Kingdom is 34 x to its reserves i.e. its actual money base.
- If more than one person in 34 walks into all banks simultaneously to withdraw their deposits, there will be a system wide bank run and a mass liquidity event with systematic default and insolvency.
- We saw the start of this with Northern Rock in the summer of 2007.
- We attempt to paper over the cracks and restore confidence in the banking system still today – with little success.
 Sterling Liquid Assets (BoE FSR, Jun 2009) A practical, politically-acceptable proposal
Our proposal is, as Irving Fisher wrote, “The opposite of radical”:
- Require 100% cash reserves to be held against all demand deposits; there can never be a crisis if a bank always holds 100% cash against all its demand deposits.
- Parliament can do this with one Act.
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”
By Steven Baker, on 1 February 10
Over at Moneyweek, Bill Bonner argues in a subscriber-only article that ersatz money is a flop.
Bonner describes John Law’s disastrous paper money scheme and the origins of ‘our current experiment with paper’. He identifies the features of the long credit boom, which has come to an end, with reserves of dollars worlwide, over consumption and over production. Bonner argues that Japan blew up first and that the planet-wide bubble burst in 2007. He says we are now all following Law’s example.
Bonner quotes — as emphasised below — Mises in Human Action:
The wavelike movement affecting the economic system, the recurrence of periods of boom which are followed by periods of depression, is the unavoidable outcome of the attempts, repeated again and again, to lower the gross market rate of interest by means of credit expansion. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.
I recommend the article, which can be read by taking a free trial.
By Dr Tim Evans, on 1 February 10
I have just accepted an invitation from that great London free market networker, Shane Frith, to address an excellent group he is involved with called Progressive Conservatives.
Not being a Conservative myself (I consider their general disassociation from much that I regard to be progressive and liberal off-putting), the chance to speak to a group professing Progressive Conservatism in the liberal sense greatly excites me.
My talk is scheduled for 22 February 2010 and the current title is ‘Free Market Thoughts on the Political Atmospherics of Money, Banking and Finance’.
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